With Google and Priceline surpassing $1000 (much less Berkshire Hathaway A shares trading at $175,000), people are amazed that stocks can trade at such high levels without being overvalued or losing liquidity, but in reality, compared with the past, most stocks are cheap nowadays. In fact, the further you go back in time, the higher was the price of average stocks to most investors. In terms of purchasing power, stocks are as cheap and as liquid as they have ever been. Not only was the average price of stocks 200 years higher than they are today, but they were higher in terms of personal income. Shares of the First Bank of the United States were issued at $400 in 1791 and shares of the Massachusetts Bank of Boston were issued at $500 in 1792. One share was equivalent to the average annual income of most people back then. Most shares sold for $100, and some for $50 or $25, so how could investors afford stocks that make Google and Priceline look cheap? Even if a stock was at $100, this was equivalent to $10,000 today in terms of earning power. Were there really that many rich people back then? The answer is no, but the difference is in the way shares were issued and traded. First, shares were rarely bought in round lots of 100 shares as they are today, but shares were traded individually. This means that even though the prices of individual shares has fallen, the average transaction size has not fallen as significantly. Second, and most importantly, shares were often bought on the installment plan, at a discount, or in fractions in order to reduce the total cost of investing. It is this second point I want to concentrate on. To see how this worked, let’s go back to the South Sea Bubble of 1720. It should be remembered that South Sea shares traded around £100 before the bubble began, which was equivalent to about $500 in 1720. One factor that allowed the Bubble to occur was that “investors” were allowed to pay for their shares in installments. The initial purchase required only 10% down with the rest of the payments spread over the rest of 1720. This was the eighteenth-century version of buying on margin. It encouraged buying because speculators, as always, thought they could make a profit before the next payment was due. It was the eighteenth-century equivalent of flipping houses. Many of them, no doubt, knew they didn’t have the full amount of money for a share, but they did have enough to get in the game. Unfortunately, the game got them. Without the speculative allure of buying in down payments, trading remained quiet in London for the next 100 years. Speculation only returned during the Canal Bubble of the 1810s, the South America and Mining boom of the 1820s and the railroad boom of the 1840s. The difference between how stocks traded in the 1840s and today is particularly striking. Again, the difference is what I call, buying on the installment plan. The par value of most stocks was £100 or about $486 using the fixed, gold exchange rate. This was almost a year’s income for the average person. Of course, the average person wasn’t investing, and most investors were people who had an endowment they had to live off of. The problem was, if you want to build a railroad and raise large amounts of money, how do you get people to part with their money? As in 1720, the answer was to pay on the installment plan. A railroad stock would be issued at £100 par. This was the amount investors were expected to put into the company; however, the company would only ask for the money as needed. The amount actually paid in was the Paid amount, and this could differ significantly from the par value. The agreement was that as the building of the railroad progressed, the corporation could assess shareholders for additional money, which they would then be required to pay in, or lose their shares. This allowed shareholders to get in on the cheap and spread out their £100 in payments over a period of several years, starting off at £10 and working their way up. As always, the hope was that if the railroad were successful, investors could use the profits to pay for the shares, and if the railroad were not successful, this process would minimize their losses. In theory, after several years, the £100 would be paid in full, and the shareholder would have made a successful investment. In reality, this created a number of complications. First, there was always the problem that someone might not have the cash ready when an assessment was due. For this reason, shareholders began to resent the fact that at any point in time the corporation could ask them for more money with the threat of the loss of shares if the shareholder did not pay. The goal was to receive money from the corporation, not pay money into it. Shareholders especially resented this when the railroad ran into unexpected problems creating a need for the investors to share the burden. It is one thing to lose money on a stock; it is another to have to pay money into the company in addition to losing your capital. This is why all shares today are non-assessable, meaning companies cannot ask shareholders for more money. The oddest result of this system was that some shares might actually trade at a negative value! In other words, someone would pay you to take their shares in the company, and we have recorded negative values for shares from the London SE. Let’s say that a share is trading at £5 and a £10 assessment is due, but you don’t have the £10, then you might pay someone £5 to take the shares off your hands and avoid the £10 assessment. Having to pay someone to take shares of a company you invested and lost money on would certainly add insult to injury. Another problem this system created was that several shares could trade simultaneously. You might have shares with £30, £40 and £50 trading at the same time reflecting the amount paid in and creating confusion. For this reason, prices were often quoted in the London Times at a premium or discount to the par value, so the same amount would be paid regardless of which shares you were buying. So if the shares were trading at a £5 discount, you would pay £25 for the £30 shares or £35 for the £40 shares. Up until the mid-nineteenth century, most shares on the London Stock Exchange that were not at their fully paid value were listed this way. There was another problem this created. When the railroad boom got going in the 1840s, stocks increased in value dramatically. If a railroad needed to raise more capital, and the shares were already fully paid in at 100 and had risen in price since then because the railroad was profitable, it became difficult to raise additional capital because the price of the shares was so high. So how do you raise additional capital? The answer was simple, you issue fractional shares. Shares were issued in halves, thirds, fourths, fifths, eighths, tenths, sixteenths, and most points in between. At any given point, a company might have a half-dozen fractional shares issued and trading. This allowed smaller investors to jump on the bandwagon and make money along with their richer friends. In addition to this, the railroad might issue shares specifically for specific routes along the railroad which would be separate from the main line. This allowed the railroad to issue new shares at lower prices on the installment plan, and since money is fungible, use the money as they best saw fit. Of course, most shareholders wanted to receive income on their shares in the form of dividends. After the railroad mania of the 1840s was over with, profits were lower and shares had declined in value. It became more difficult to raise money from this sector of the investing public, so some of the railroads began issuing “preferred” shares which were paid ahead of the common stocks. In fact, it was the London and Greenwich Railway which was the first to do this, issuing a 5% preferred in April 1842. By the time the railway mania of the 1840s was over, the result was that the outstanding securities of some railroads were a mess. Most railroads never made it to the full £100 paid in, so the paid in value was only a portion of their par value. In addition to that, fractional shares were outstanding, and there were the shares from extension lines of the railroad as well as shares in railroads taken over during the boom, which usually traded separately from the parent shares. To eliminate the confusion, railroads consolidated shares once the building boom was over with. If a £100 par share was at £20 paid, the company would do a 1:5 reverse split turning the stock into a £100 par share. If there were half shares or quarter shares outstanding, they would do a 1:10 or 1:20 reverse so all the fractional shares were eliminated. If an extension rail line was at £10 par, it would have a 1:10 reverse. Consequently, all the shares would be consolidated into a single security. By the late 1800s, capital was flowing freely enough that all the measures that had been used to make shares “affordable” were no longer needed, and new shares were issued at £100 and the whole system of downpayments, fractional shares, and other half-measures weren’t necessary anymore. Nevertheless, there was a final interesting phenomenon which occurred in London to make shares more accessible to the public. When the bull market of the 1920s occurred, the high price of stocks kept most shareholders out of the market, even though punters wanted in. Companies found a quick solution to making their shares more liquid and bringing in more capital. In the US, companies would split their stocks 4:1 or 5:1 as the price rose to make the shares more affordable, and speculators could go to bucket shops to trade on margin, but in London, shares were sometimes split 100:1 to get the par value down from £100 to £1, and there are even cases of stocks splitting 400:1 to get the par value down to 5 shillings (or about $1). This helped to feed the bull market in stocks in London, but as we all know, the 1920s bull market ended in the crash of the Great Depression, though stocks fell around 50% in London, as opposed to 90% in the United States. The bottom line is, companies will always find a way to make their shares available to the public to raise money and maintain liquidity in their stocks. Some may criticize high-frequency trading, but it has made the markets more liquid. It is easier and cheaper to trade odd lots than ever, so if you only want to buy 10 shares of Google, then do so. Markets have always accommodated investors, and always will.

As with many financial panics, this one began when unexpected events in one part of the Roman world spread to the rest of the Empire. To quote Otto Lightner from his History of Business Depressions, “The important firm of Seuthes and Son, of Alexandria, was facing difficulties because of the loss of three richly laden ships in a Red Sea storm, followed by a fall in the value of ostrich feather and ivory. About the same time the great house of Malchus and Co. of Tyre with branches at Antioch and Ephesus, suddenly became bankrupt as a result of a strike among their Phoenician workmen and the embezzlements of a freedman manager. These failures affected the Roman banking house, Quintus Maximus and Lucious Vibo. A run commenced on their bank and spread to other banking houses that were said to be involved, particularly Brothers Pittius. “The Via Sacra was the Wall Street of Rome and this thoroughfare was teeming with excited merchants. These two firms looked to other bankers for aid, as is done today. Unfortunately, rebellion had occurred among the semi civilized people of North Gaul, where a great deal of Roman capital had been invested, and a moratorium had been declared by the governments on account of the distributed conditions. Other bankers, fearing the suspended conditions, refused to aid the first two houses and this augmented the crisis.” At the same time, agriculture had been on the decline for several years, and Tiberius required that one-third of every senator’s fortune be invested in Italian land. The senators had 18 months to make this adjustment, but by the time the period was up, many senators had failed to make the proper adjustment. This deadline occurred at the same time as the events above occurred, placing a further squeeze on the financial sector. When Publius Spencer, a wealthy noblemen, requested 30 million sesterces from his banker Balbus Ollius, the firm was unable to fulfill his request and closed its doors. Over the next few days, prominent banks in Corinth, Carthage, Lyons and Byzantium announced they had to “rearrange their accounts,” i.e. they had failed. This led to a bank panic and the closure of several banks along the Via Sacra in Rome. The confluence of these seemingly unrelated events led to a financial panic. To protect themselves, banks began calling in some of their loans. When debtors could not meet the demands of their creditors, they were forced to sell their homes and possessions, and with money unavailable even at the legal limit of 12%, prices of real estate and other goods collapsed since there were so few buyers. A full scale panic followed. The panic occurred not only in Rome, but throughout the Empire. If anyone thinks that it is only in recent times that financial markets have been so fully integrated that the failure of the Creditanstalt in 1931 or Lehman in 2008 could precipitate a panic, they clearly have not read their history. By their nature, financial markets have always been integrated, and failure in one part can create the domino effect which created the Great Depression and was witnessed in 2008. Tiberius had retired from Rome. Although a great general, some felt Tiberius never wanted to be emperor, and he became reclusive in his later years. It took time to contact him and get a response. Several days later, he sent a letter to Rome with measures to alleviate the crisis. The decrees which had precipitated the problem were suspended. 100 million sesterces were to be taken from the imperial treasury and distributed among reliable bankers, to be loaned to the neediest debtors. (A loaf of bread sold for half a sestertius and soldiers earned around 1000 sesterces, so if you take an average soldier’s salary of around $20,000, you could say that one sestertius was equal to about $20 today.) The 100 million sesterces was equivalent to around $2 billion. No interest was to be collected for three years; but security was to be offered at double value in real property. This enabled many people to avoid selling their estates at low prices, stopping the fall in prices and ensuring that the lack of liquidity never occurred. Though a few banks never recovered from the panic, most continued business as usual, and the financial panic ended as quickly as it began. If you think about Tiberius’s response, it is little different from what Bagehot would have recommended in Lombard Street, written in1873, or what Bernanke did in 2008. Just as Bernanke expanded the balance sheet of the Fed, Tiberius increased liquidity by a huge amount, an early version of the TARP. Tiberius lowered interest rates to zero for three years to alleviate any additional pain, again, little different from the quantitative easing the Fed has carried out to keep both short- and long-term interest rates low. The financial crisis of 33 AD also illustrates how integrated all parts of the Roman Empire were since it involved not only Rome, but Egypt, Greece and France. The financial panic took place over a period of a few weeks, one collapse precipitating the other, just as problems at Lehman, AIG and Morgan Stanley quickly led to problems in other parts of the financial sector and the real economy. The financial crisis was resolved with Tiberius’s measures, and the downward spiral was stopped. When Tiberius died in 37 AD, he had a fortune of 2.7 billion sesterces, or over $50 billion. Unfortunately, his successor was his son Caligula, who was, to say the least, not as refined in his judgments as Tiberius was.

The Florida Land Bubble of the 1920s has been hailed as a precursor both to the Stock Market Bubble of the late 1920s and the real estate bubble of the 2000s. Unlike the stock market crash of 1929 or the real estate bubble of the 2000s, there is insufficient evidence for the price fluctuations, so most of the data are anecdotal. One of the stories, possibly apocryphal, that illustrates the impact of the Florida land boom was this story. An elderly man in Pinellas County was committed to a sanitarium by his sons for spending his life savings of $1,700 on a piece of Pinellas property. When the value of the land reached $300,000 in 1925, the man’s lawyer got him released to sue his children. Global Financial Data has data on just such a candidate: The Land Company of Florida. Although it doesn’t track the rise in Florida real estate prices, the company was formed in 1924 and does track the fall in real estate prices that occurred. The Florida Real Estate Bubble was the most egregious example of a trend that had started during World War I. The commodity inflation of World War I encouraged many farmers to borrow against their farms and buy additional property anticipating further increases in both food and real estate prices. This led to a general increase in real estate prices during the 1920s throughout the United States before foreclosures started becoming more common in the late 1920s, culminating in the massive foreclosures of the 1930s caused by the Dust Bowl and Depression. In the middle of this real estate boom was the Florida bubble. In the 1920s, Americans had more money, more leisure time, were more willing to speculate, and were able to use their automobiles to travel to Florida and other places creating markets that hadn’t existed before. All of these factors enabled Florida to take advantage of these trends to promote the Florida land boom. The Florida Legislature in 1924 passed laws prohibiting state income and inheritance taxes to convince wealthy visitors to make Florida their permanent residence. Land developers then promoted real estate by building cities where none existed before. The most spectacular developments were in Southeast Florida where Henry Flagler’s railroad caused direct access to New York City. Other factors attracting investors was the influx of motorized tourism which brought both rich and poor visitors, and the rum runners who were able to bring in alcohol from Nassau and Grand Bahama to help visitors avoid Prohibition. About two-thirds of all Florida real estate was sold by mail to speculators who never visited Florida. Many of them tried to flip the land through ads in the Miami Herald. For those who actually went to Florida, binder boys were hired to expedite purchases. The binder boys got down payments with thirty-day financing and once the checks cleared, the binder boys received their commission. When there is money to be made, people find ways to make a quick profit. What started out as an undervalued market turned into an overvalued bubble. Then reality set in. A serious of events made investors realize how fragile the price increases were. Forbes magazine warned about the overpriced real estate in early 1925. In October 1925, the “Big Three” railroad companies operating in Florida called an embargo due to the rail traffic gridlock, permitting only foodstuffs, fuel, perishables, and essential commodities to enter or move within the state. Although the railroads lifted the embargo in May 1926, disaster then followed in the shape of the September 1926 Miami hurricane which killed over 400. A market where there were mainly buyers became a market in which there were mainly sellers and the real estate market collapsed. The evidence for this bubble is the Land Co. of Florida incorporated on June 16, 1924. The company was a subsidiary of Florida Western & Northern Railroad Co., and was organized to purchase upwards of 160,000 acres of land along the right-of-way of the Florida Western & Northern Railroad. The stock was a real estate investment trust trying to profit from the real estate bubble and provides a useful proxy for the Florida real estate market. After acquiring the land, the company would then sell the land when its value had been enhanced by the easy accessibility afforded it by the new railroad. Or so things were in theory. The stock traded on the New York Curb (later the American Stock Exchange) and traded in September 1925 at 93. After the train embargo was announced in October, the price fell to the 60s, and continued to fall, decreasing to the 20s by February 1926. One would expect that the hurricane of September 1926 would have caused a further collapse, but in reality, the stock price rose after September, hitting 41 in December. Perhaps the impact of the hurricane should be reevaluated, but it was downhill from 1927 on. By the time the stock market crashed in October 1929, the price had fallen to 5 and by the end of 1930, the stock was at $0.50, never to recover. The stock stopped trading on the Curb in May 1931.

Once again, the government has cut a deal to avoid defaulting on its debt by raising the debt ceiling. The chance of the United States defaulting on its debt has been avoided, at least until January 15, 2014. The reason for these dramatic battles over the debt ceiling is that originally, each bond issue by the government had to be approved by Congress. When the United States entered World War I, instead of requiring that the government approve each and every bond issue, the government changed tack and set a general debt limit, enabling the government to issue new bonds at will up to the limit that was established. It may surprise you, or probably not, but even when the government had to approve each bond issue, prior to World War I, the United States almost defaulted on its debt because of political wrangling. OMG! How shocking. This happened in 1895 when the United States was on the Gold Standard as Jean Strouse related in her book, Morgan: American Financier. In 1895, the United States was suffering through the recession that followed the Panic of 1893. Foreigners were selling their stocks and bonds and were converting their dollars into gold which was sent out of the United States. Between 1890 and 1894, foreigners had redeemed $300 million in gold. By the end of 1893, US gold reserves were down to $60 million and about $2 million in gold was being redeemed each day. By February 1894, the US government had about three weeks of gold left in its vaults. After that, the US would have to technically default on its debts because it would be unable to redeem the demand for gold that foreigners would make. Sound familiar? Congress was aware of this problem and knew of the possibility of default, but many Representatives thought this “emergency” was being created by the money interests in New York, and in particular, J. P. Morgan, to force the government to issue bonds and put the government further in debt. President Grover Cleveland, a Democrat, knew this, but wanted to avoid default. He contacted Nathaniel Mayer Rothschild to help, who in turn contacted J.P. Morgan. One problem was the Secretary of the Treasury, John G. Carlisle. Carlisle thought the bond terms were too tough, and he wanted Congress to issue bonds directly to the public. The problem was there wasn’t enough time to do this without the government going into default, and whether the bill could get through Congress was questionable. Do you have a feeling of déjà vu all over again? Although Secretary Carlisle was a staunch Agrarian Democrat, similar to William Jennings Bryan, he eventually responded to the economic downturn caused by the Panic of 1893 by ending silver coinage and opposing the 1894 Wilson-Gorman Tarrif Act bill. By 1896, Carlisle was so unpopular that he was forced to leave the stage in the middle of a speech in his home town of Covington due to a barrage of rotten eggs. Those were the days. Realizing that time was of the essence, J. P. Morgan took a train to Washington D.C. At first, Cleveland didn’t want to meet with him. Even though most members of the cabinet favored the bond issue, Carlisle was against it. In reality, the government was technically in default. There were $12 million in warrants for gold outstanding with only $9 million in the vaults. Unless something was done immediately, the United States would be in default for the first time in its history. J.P. Morgan, however, had a trick up his sleeve. During the civil war, Congress had authorized then Treasury Secretary Salmon P. Chase to issue bonds that could be offered for coin. By calling this a bailout for coin, the government could do an end run around Congress and issue the bonds without Congressional approval. Attorney General Olney investigated, found the clause was still valid, and gave his approval. President Cleveland asked that the international bailout team of Morgan and Rothschild keep the gold in the United States. The government agreed to buy 3.5 million ounces of gold from the bailout team at $17.80 per ounce, in exchange for $62.3 million worth of 30-year bonds paying 4%. Since the price of gold was $18.60 per ounce, the government ended up paying $65.1 million in gold for $62.3 million in bonds, earning the bailout team $3 million. Twelve days later, the bond offer was made, and it sold out in 20 minutes. The data for this bond shows that purchasers of the bond did well. Not only did the US pay $3 million extra for the bonds, but the price shot up to 125 after issue, yielding 3.2%, so the US could have gotten a better coupon yield as well as a better price. The 30-year bond was redeemed in 1925 at 100, trading above its par value, particularly during World War I, during the entire time of its issue. Whether the issue is establishing a first or second Bank of the United States, issuing bonds to make sure the United States doesn’t run out of gold, raising the debt ceiling to make sure the government can pay its bills, or any other government financial crisis, the players are the same and the result is the same as well. As the saying goes, I’ve seen this movie before. It’s the Washington version of Groundhog Day. One hundred years from now when the US government has its twenty-second century version of potential default with only days and hours before the United States defaults on its debt for the first time, the movie will be the same, as will the ending. Be sure and re-read this blog in January 2014, and in 2015, and in 2016, and…