Amsterdam Banking Crisis of 1763

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The Amsterdam Banking Crisis occurred in 1763.[why?]


On February 10, 1763, the Treaty of Hubertusburg was signed in Germany. This Treaty marked the end of the Seven Years' War, a war from 1756 to 1763 that involved all of the major European powers of the period. This treaty ended the war with no significant changes in borders. In the years during the War, Amsterdam banking firms reaped large profits with money trades and loans to other European banks, which lent the money to their governments that needed the money to finance their war efforts. To cover the loans, large quantities of goods were sent to Amsterdam. But in 1763, because of the end of the war, the abnormal high war prices plummeted and commodity and goods lost their value rapidly. More than 30 banking and trade firms went bankrupt, with an estimated debt of 20 million Dutch guilders. During the economic boom and credit expansion that followed the Seven Years' War, Berlin, for example, was the equivalent of an emerging market, and Amsterdam’s merchant bankers were the primary sources of credit, with the Hamburg banking houses served as intermediaries between the two.

But some Amsterdam merchant bankers were leveraged far beyond their capacity. Financial activity in late-eighteenth century Amsterdam was controlled by a group of merchant banking firms. These “bankers” were proprietary firms that dealt in trade goods and that also provided financing to other merchants. These firms were not deposit banks in the English conventional tradition, as deposit taking was viewed as incredibly risky. Since deposits were scarce, financial intermediation was accomplished through a securitization scheme known as the acceptance loan. The building block of the acceptance loan was an instrument known as the bill of exchange — ultimately a contract to pay a fixed sum of money at a future date. Bills of exchange were originally designed as short-term contracts but gradually became heavily used for long-term borrowing. They were typically rolled over and became de facto short-term loans to finance longer-term projects, which resulted in the creation of a classic balance sheet maturity mismatch. At that time, bills of exchange could be re-sold, with each seller serving as a guarantor to the bill and, by implication, insuring the buyer of the bill against default. This practice prevented the circulation of low-credit-quality bills among market participants and created a kind of “credit wrapper”—a guarantee for the specific loan—by making all signatories jointly liable for a particular bill. In addition, low acceptance fees—the fees paid to market participants for taking on the obligation to pay the bill of exchange—implied a perceived negligible risk. However, the complexity of this system had underlying ramifications - the practice also resulted in binding market participants together through their balance sheets: one bank might have a receivable asset and a payable liability for the same bill of exchange, even when no goods were traded. By the end of the Seven Years' War in 1763, high leverage and balance sheet interconnectedness left merchant bankers highly vulnerable to any slowdown in credit availability.

Merchant bankers believed that their balance sheet growth and leverage were hedged and insured through offsetting claims and liabilities. And while some of the more conservative Dutch bankers were wary in growing their wartime business, others expanded quickly. One of the fastest growing merchant banks belonged to the de Neufville brothers, who speculated in depreciating currencies and endorsed a large number of bills of exchange. Leendert Pieter de Neufville was the leading perpetrator of the proliferation of the faulty bills of exchange. Noting his success, other merchant bankers followed suit. The crisis was triggered when the brothers entered into a speculative deal to buy grain from the Russian army as it left Poland. But with the war’s end, previously elevated grain prices collapsed by more than 75 percent, and the price decline began to depress other prices. As asset prices fell, it became increasingly difficult to get new loans to roll over existing debt. Tight credit markets resulted in distressed sales and further price declines. The depreciation of the asset prices resulted in the credit markets drying up, and subsequently merchant bankers began to suffer direct losses when their counterparties went bankrupt.

The Dutch financing structure, of issuing securitized debt before the original borrowers were paid, came to a halt in late July 1763 when the de Neufville bank house failed in conjunction with failed payments to a minor firm called Aron Joseph en Compagnie. Their failure caused the failure of all their creditors around Amsterdam as well, as well as failure in Hamburg and Berlin.

The failure of a firm of Neufville’s size – almost half as large as the Bank of Amsterdam itself – shocked the Amsterdam markets. The immediate victims were a group of firms known as “cashiers.” The cashiers were about 30 financial intermediaries whose activities formed a bridge between the large banks and merchants. Traditionally, the cashiers had served as brokers in the market for bank funds. By the last half of the eighteenth century, their activities had expanded to include settlement of bills denominated in current guilders, deposit taking, and even the issue of cashier’s receipts that circulated locally as bank notes. The cashiers were run hard during the first days of the crisis, as panicked holders of cashier’s receipts demanded coin from the issuers. The contraction of the bill market put the Amsterdam merchant bankers under heavy pressure, as their ability to roll over funding was several constricted.

Policy response[edit]

The post-Neufville credit freeze-up ultimately forced 38 Amsterdam firms into bankruptcy during August and September 1763. Compared to Neufville, however these were small enterprises, and many were able to reopen within a few months, after settling with creditors. By October, there are signs of the market returning to a more “normal” state, albeit at lower levels of activity than before. Scholars argue that a major reason for the comparatively mild impact of the panic in Amsterdam was the provision of liquidity through the Bank of Amsterdam, which was able to compensate for a shortage of market liquidity. This was accomplished by two methods: the first being the traditional repo window for trade coins. The second was the novel idea of a repo window for unminted silver bullion (the bullion window was authorized on August 4).

Coin deposits at the Bank of Amsterdam functioned much as modern central bank repurchase transactions. Differently from the usual practice of modern central banks, however, the Bank did not try to actively vary the terms of its coin window. Nor did it attempt to manage the quantity of receipts outstanding, but simply allowed these to adjust to market conditions. Thus, when Neufville collapsed, bankers, to maintain their overall balances, created two million new bank guilders by bringing coin collateral into the bank.

The second operation used to restore damages from the Neufville failure was the bullion window. In short, the policy dilemma facing the Bank of Amsterdam in 1763 an extraordinary demand for central bank balances, combined with a surfeit of collateral, only most of it not eligible for transactions with the central bank. Thus, the improvised solution was for the Bank to expand its repo window to include unminted bullion. In designing this program, a key political constraint was that the bank did not undercut the business of the mints, a major source of governmental revenue. Combined, these two solutions helped curb the effects of the failure of the de Neufville banking house.

Overall there were many lessons learned by the Crisis. A combination of the system including securitization of numerous embedded liabilities, a large shock to collateral values, and erratic policy decisions all came together to produce the Crisis. The trigger is provided by the collapse of a Neufville, who was too “interconnected to fail.” The solution of providing unlimited amounts of liquidity (coin repo window), on fixed terms, was a brilliant strategy and one that would be replicated during the 2008 Crisis. As well, the bullion window, though used lightly, was effective for its limited purpose. These two liquidity measures dually prevented additional failures of major market participants.


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