Advice To The President: Addressing A Financial Crisis In The First Year
University of Virginia – Darden School of Business
November 15, 2015
Abstract:
If confronted with a major financial crisis in the first year (2017) of his or her first term, what should the new President do? This essay explores the history of some of the financial crises in the United States and offers lessons for the new administration to help it prepare for such events during its first year. Eight episodes from history frame recommendations in respect to policies and priorities, processes, personnel, and politics. The sweep of history shows a trend of rising presidential intervention in material financial crises. The best presidential responses were agile, not doctrinaire, were strategic, not tactical; and promoted transparency, not opacity.
Advice To The President: Addressing A Financial Crisis In The First Year
To the new President:
Eight of your predecessors confronted a major domestic financial crisis in the first year of their administrations:
- John Adams, Panic of 1797. Unbeknownst to Adams, a week before his inauguration, the Bank of England suspended payments in gold, which triggered a severe credit contraction in Britain and the U.S. The contraction burst a bubble of speculation in land and bankrupted merchants and speculators. Adams took no specific action about the Panic of 1797, probably because there was scant precedent for a national government to rescue banks, relieve the unemployed, and stimulate economic growth. The midterm elections of 1798 produced growing tensions between nascent political parties. Adams’ strategy was to steer a middle course between the parties, which doomed his chance for re-election in 1800.
- Martin Van Buren, Panic of 1837. Within weeks after his inauguration, a bank panic broke out in New York and other Eastern cities. This had its roots in rising interest rates in Britain, the falling price of cotton, and policies of Van Buren’s predecessor, Andrew Jackson. In May, 1837, Van Buren called for a special session of Congress, to convene in September. His proposal was to reorganize the U.S. Treasury to hold gold reserves in federal sub-treasuries, rather than banks, around the country. Congress balked until 1840, when it approved the bill. Popular anger over the panic and subsequent depression echoed in the mid-term election of 1838, which enlarged seats of the opposition party in Congress. Van Buren lost his bid for re-election in 1840.
- James Buchanan, Panic of 1857. Rising interest rates in England and the U.S. pierced a speculative bubble in land and shares of stock in new railroads. The collapse from August to October 1857 of institutions who had financed the speculations triggered bank runs and suspensions across the nation. The economic contraction sparked riots for bread and strikes by workers. And government tax revenues plunged. Buchanan’s specific response to the crisis was to hold the states responsible for relief to unemployed workers; he said that the federal government was “without power to extend relief.” The panic aggravated debates over tariffs, homesteading, and slavery, and generally contributed to the widening gulf between the North and South. The midterm elections saw major losses to Buchanan’s party. Buchanan retired from public life in 1861.
- Abraham Lincoln, Panic of 1861. With the onset of the Civil War, Lincoln and his Treasury Secretary Chase strained to finance the military buildup. Congress approved new taxes and authority to issue bonds. In December, 1861, the Treasury sold $150 million in bonds to banks, who were required to pay for the bonds in specie (gold and silver). This massive drain of specie, plus public disbelief in the stability of the banking system, prompted panic. The banks responded by suspending specie payments. The Treasury followed suit by suspending specie payments on its notes. In February, 1862, Lincoln signed the Legal Tender Act, which would sustain specie suspension by the federal government for two decades, and launched the “greenback era” of fiat money. The Democrats made significant gains in the elections of 1862, attributable not only to the banking crisis, but also to emancipation, suspension of habeas corpus, and endorsement of a militia draft. In February, 1863, Lincoln endorsed the National Banking Act, which reformed the financial system and introduced federal regulation of nationally-chartered banks.
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