Englishman Who Fooled America

It has been 228 years since he crashed the market, but his name is still remembered in the history of financial crises. Please welcome William Duer, a British-born American lawyer, developer, and, most importantly, a speculator from New York City. He is now known as an Englishman who fooled America. 

Without any doubt, Mr. Duer was a talented person. Besides being an entrepreneur, land speculator and settlement promoter of the Northwest Territory (aka Ohio), he was also the first secretary of the Board of the Treasury, founder of the Society for the Encouragement of Useful Manufactures (co-founded with Alexander Hamilton) and a signer of the Articles of Confederation.

However, he will go down in history as the creator of the first U.S. stock market crash in 1792 using stock and bond options. Had it not been dealt with as effectively as it was, it might have destroyed the financial revolution.

The question should be asked, why should one care? As writer and philosopher George Santayana said, "Those who cannot remember the past are condemned to repeat it." But, most importantly, it can provide insights into the nature and functioning of the early stock exchange.

William Duer showed that financial markets are vulnerable to manipulation, swindles, and fraud, after attempting to corner the market of United States government bonds in 1791-1792. Despite the fact that it led to more effective securities trading and clearing systems, and the founding in 1792 of what would become the New York Stock Exchange, it took regulators over 200 years to understand that more serious changes should be made to protect the market stability.  

Probably, for that reason, his “feat” was repeated by: 

• The life insurance companies of the early 19th century, which took premiums for customers but disappeared before paying any claims;
• Ferdinand Ward, known as "the Napoleon of Wall Street". He was actively borrowing money from banks and investors and using the proceeds to buy stocks. Ward pledged the same securities to support more than one bank loan (required to speculate in the market). The stock market began to fall in 1883, but Ward managed to extract money from Grant’s family, his friends, and acquaintances. It allowed him to give the money back to earlier investors. The scheme collapsed in 1884, bankrupting Ulysses S. Grant, Sr. and many other investors.
• Samuel Insull, a man who brought electricity to Americans.  To pay for expansion, Insull had sold low-price bonds and stock. Over a million middle-class Americans bought in but their investments were made worthless by the Great Depression. Overnight, Insull went from a hero on the cover of Time magazine to the villain who had stolen the people's money. 
• The pyramiding scheme of Charles Ponzi in 1920; 
• The highly suspect practices of New York’s National City Bank and its chairman, Charles Mitchell, in the run-up to the Great Crash of 1929. 
• In the 20th century, Mr. Bernard Madoff took the lead with a massive Ponzi scheme.
• Of course, the list of fraudsters doesn’t end there… 

At least now, we know that an effective regulatory system must manage risk, facilitate transparency, and promote fair dealing among market actors. The question must be asked, is the current system offering all three counts?

The first bank of the United States

The war for independence left the young nation, and many of its citizens, heavily in debt. The situation deteriorated even further with the rampant inflation, bankrupting many people. However, the country didn’t give up.

Here I would like to ask you to turn on the 

Broadway musical Hamilton

.

Alexander Hamilton, the first Secretary of the Treasury decided to research the history and economic structure of other countries, especially France and Britain, for ideas on how to build a nation. Hamilton studied the works of philosophers David Hume and Adam Smith, as well as England’s use of public debt. It is worth noting that this type of funding had helped to build England’s military might and pay for its wars and had enabled the British to build an empire. 

In December 1790, Hamilton submitted a report to Congress in which he outlined his proposal for creating a national bank. He used the example of the Bank of England as the basis for his proposal. Hamilton believed that such an institution could issue paper money, provide a safe place to keep public funds, offer banking facilities for commercial transactions, and act as the government’s fiscal agent, including collecting the government’s tax revenues. 

Even though, things didn’t go smoothly for Mr. Hamilton. In particular, Secretary of State Thomas Jefferson was afraid that a national bank would create a financial monopoly that would undermine state banks. Other opponents thought that the bank was an affront to states’ rights and would make the states too subservient to the new federal government.

He didn’t give up and in the winter of 1791 Hamilton’s bill cleared both the House and the Senate. On December 12, 1791, the First Bank opened for business in Philadelphia.

When the bank subscriptions went on sale in July 1791, they sold out so quickly that many would-be investors were left out and had to try to bid them away from those fortunate enough to have obtained the scrips. Many borrowed money to do so. 

It is worth noting that at its IPO, the First Bank did not directly sell shares for immediate delivery, but rather “scrips,” which cost $25 each, payable in specie (gold or silver). This money acted as a down payment on buying bank stock, which sold for $400 a share. Investors would then pay the balance due over the course of the next two years (until July 1793). One-quarter of the amount due would be paid in specie and the remaining three quarters in U.S. debt securities.

And the speculation began. Very soon, bank scrips doubled in price as many people borrowed money in order to buy the scrips to obtain the bank’s stock. As a result, the bubble burst by the end of August 1791, and prices fell, in some cases by more than $100.

The need for intervention was obvious. So, Alexander Hamilton asked fellow members of the Treasury to authorize purchases of government securities in the marketplace. The commissioners agreed to do so. After that, government securities and bank scrip surged to new highs during the winter of 1791-1792. Among the speculators was the hero of this story, William Duer, Hamilton’s old friend and former assistant at the Treasury Department.

At the end of 1791, Duer cooperated with a wealthy land speculator named Alexander Macomb to corner the market on U.S. government securities. In addition, Duer was borrowing heavily to pay for his investments. The plan was to sell the appreciated assets to other investors at a significant profit.

Some claim that Duer would purposely leak news stories about companies he was investing in the press in order to make the share price rise. There were no regulatory agencies to monitor such actions. This is why Duer could leak stories.

Like a fish, Duer was hooked on speculation. He began buying additional bank securities on contract, with a promise to pay within two weeks. Duer was sure the securities would grow and the money he borrowed could easily be repaid. 

If only prices had risen... The bank merger didn’t happen and stock prices began falling. In early 1792, the First Bank suddenly slowed the expansion of its loan pool and in turn slowed the number of banknotes it issued, other banks followed suit, creating another credit crunch.

In March, a selloff of these assets began, thus bankrupting not only Duer but everyone else who was willing to lend money to him. The number of people and companies he had borrowed from was so large that his undoing, in turn, led to widespread financial contagion. Other investors also started to sell off securities and default on their loans. This crisis has become known as the Panic of 1792.

In order to prevent the catastrophe, Hamilton once again appealed to the Treasury buying government securities in the open market. It calmed the markets and allowed the fledgling U.S. financial system to return to more normal operations.

P.S. Pierre de Poyster was the only person to wring his money out of Duer. He arrived at the jail with pistols and telling Duer to pay up or let a duel decide his fate. William Duer himself died in 1799 in prison. In May 1792, 24 brokers met under a buttonwood tree to sign a brief, two-sentence agreement. So-called Duer’s acts were meant to shut out speculators from the market. For several decades, this group of brokers conducted business from the second floor of the nearby Tontine Coffee House. In 1817, that club became the New York Stock Exchange.