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Panic of 1857: Railroads are the new thing
Investors' subprime mortgage fear is nothing new -- 150 years ago, much the same angst was called the Panic of 1857.
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Railroads are the new thing. Their securities dominate the stock and bond markets of the day. Virtually everyone gets into the game, from stockbrokers to small farmers in Wisconsin who pay for railroad stock with notes collateralized by mortgages on their farms, to state and local governments and foreign investors.
No one is quite sure what is going on financially. Disclosure requirements and standardized accounting don't exist. At the same time, speculators are buying and holding land out West for sale, eagerly anticipating big flows of migrants. And banks -- many of which are only lightly regulated -- are happily using call loans backed by stock and mortgages as reserves.
So what we've got is not much oversight, spotty information about the valuation of assets, interlocking financial and capital relationships and expectations that a certain type of property (land and railroad investments) will continue generating breakneck price increases.
Then what happens? Realities that remind people that what goes up doesn't always keep going up: The Dred Scott case opens the West to slavery. Then a guy named Leonard Jerome uses the newspaper to trumpet some shady dealings by the Michigan Southern Railroad; its stock drops like a brick and causes the New York branch of the Ohio Life and Trust Co. (a bank) to go belly-up. Railroad stocks plummet, the land market stagnates, banks refuse to pay out gold and silver, bankruptcies proliferate, domestic and foreign investors lose their shirts, people get thrown out of work, migrants stop moving west. Misery ensues.
Fast forward a century and a half: Subprime loans go to people who are poor credit risks. Financial whizzes figure out cool new investment prospects such as mortgage-backed securities and collateralized debt obligations that become so complicated that many investors probably don't really understand how they work or why they are priced and rated as they are. But they think housing prices will just keep zooming up and subprime loans will just keep performing.
Everyone gets in on the action. Then, surprise, surprise -- risks turn out to be, well, risky.
JENNY WAHL
CARLETON COLLEGE ECONOMIST
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