How do i industry sign banking louisiana presentation now
- Very early on in our planning, we knew that it would
be very important for us to have a speaker here among us who could inform us with some authority what it was like to be a
banker during these various centuries of our tale, because, surely, to be a Piero de' Medici was different from being a Robert Lehman, and it is for that reason
that we've turned to Richard Sylla to help us gain that firmer footing on
that aspect of our topic. Richard Sylla is the
Henry Kaufman Professor of the History of Financial
Institutions and Markets and professor of economics at the Stern School of Business
of New York University. He is also a research associate
of the National Bureau of Economic Research. Professor Sylla received his
B.A., M.A., and PhD degrees from Harvard University, and his research focus is
on the financial history of the United States in
comparative contexts. He is a former editor of the
Journal of Economic History and has served as chairman of the board of the Trustees of the Cliometric Society, I hope I'm saying that right, and Association of
Quantitative Historians. You can tell I'm a little
out of my depth here. As president of the Economic
History Association, the professorial organization
of economic historians in the United States, and as president of the
Business History Conference, the leading professional
association of business historians, which also presented him
with its lifetime achievement award. Richard is a fellow of the
American Academy of Arts and Sciences, and currently serves as the
chairman of the Board of Trustees of the Museum
of American Finance, a Smithsonian affiliate
located in Wall Street, here in New York. He is the author of "The
American Capital Market, "Eighteen-Forty Six to Nineteen Fourteen," and co-author of "The Evolution
of the American Economy," published in 1993, and "A History of Interest Rates," that might interest us, (chuckles), that was, that is in its fourth edition in 2005. He's the co-editor of
"Patterns of European "Industrialization in the 19th Century: "The State, The Financial
System, and Economic "Modernization," and of "Founding Choices:
American Economic Policy "in the 1790s," as well as numerous essays,
articles, and reviews in business, economic, and
financial history magazines. This afternoon, Richard
will give us this historical perspective that I, for one, badly need on what it was like to be
a banker at various moments in history, in his presentation, "The Art of Banking Since the Medici." Please join me in welcoming Richard Sylla. (audience applauds) - A good banker should always have a
supply of liquidity nearby. (audience laughs) And that's true of a professor as well. Inga, thank you for those kind remarks. And, I want to thank the
Frick for inviting me to be here today. I'll just plunge right in, I have a Power Point
presentation that doesn't have a lot of artwork in it. It's got a couple of securities in it, but not much artwork. Because, you're going
to get so much of that in the symposium that I'm
going to stay away from it. So, first slide. I want to say the banks, for centuries, have played a key role
in economic development. Of course, I teach at the Stern School. I try to point out that
the countries that had the most developed banks and
really the most developed financial systems, early on, were the ones that were
successful in modern history. The northern Italian city
states are an example, and what I noted here was that, these city states of northern Italy, about five, six, seven hundred years ago, developed modern banking, innovated it, and they also innovated double-entry bookkeeping. "Banco" as some of you may know, is the Italian word for
"bench" or a small table, and the, the new sort of businessman in history appeared in those northern
Italian city states in the Middle Ages. He would come with his little table, or bench, and he would open up his
account books on there, and on one side, he would
take deposits from people, pay them some interest rate. On the other side, he would
make loans to other people, charge them a somewhat
higher interest rate and live on the spread, and since the most obvious
thing that this new businessman had to identify him was the little table or bench, the banco, he got to be known as a banchiere, and the word spread to
Germany and England, banquier in French, and so on, and so that's some of the early history of banking. By the time we take it
up, I think the Italian city states were the richest
economies in the world. They'd had banks for a couple of centuries, the Medici Bank was by
no means the first bank in the 15th century, and those, we have some data, rough data I'm sure, but they indicate that
northern Italy was the richest economy in the world, around 1500 or so, and of course, we know that that banker well sponsored art. Examples? We've heard about both of
my examples here today, the Medici Bank was a bank
that lasted not quite 100 years from 1397 to 1494, and the other example, which
was just mentioned by David, the Monte dei Paschi of Siena, which was, you know, it's not the oldest bank in the world, it's the oldest bank in the
world that still exists. It may not exist much longer, so we'll have to maybe
be looking for another bank that's the oldest bank in the world that still exists, pretty
soon, because as David said, it's gotten into a bit of mischief lately. But, 1472, it's well over 500 years old. Now, the Italians were the innovators. Banking spread from Italy, the Dutch Republic, even earlier in the low countries when they were colonies of Spain, or the Holy Roman Empire, the Dutch Republic adopted and improved on some of the Italian financial
innovations around 1600. They developed something of a central bank called the Bank of
Amsterdam which was founded in 1609. The Amsterdam Beurs or Stock Exchange was founded around the same time and the Dutch were beginning to cook. It was also in 1609 that the Dutch sent an English sea captain named Henry Hudson to explore, and he came into New York Harbor, and so you see three big events of 1609, the Bank of Amsterdam, the Amsterdam Beurs and the
Dutch East India Company hiring Henry Hudson to
come to explore New York, what we know now as New York Harbor, and then the 1620s, another Dutch company, the Dutch West India Company actually put a settlement
on Governors Island and later on lower Manhattan, so this is early in the 17th century, and, some decades later, the Dutch have their Golden Age, or what
the historian Simon Schama has called the Embarrassment of Riches, and we know that the
Dutch masters flourished in the middle part of the 17th century, but the banking came first, so the point I want to make
as a financial historian is that, you know, we're
talking about how bankers make money, but bankers do all kinds of good to develop, develop economies. After the Dutch, the English had their glorious revolution, roughly a century later, 1688. And England adapted and improved upon the Dutch financial innovations. The Bank of England was
more of a modern bank than the Bank of Amsterdam was. It was founded in 1694. England then went on, with these financial innovations that involved things like
the government bond market and stock market as well
as the Bank of England and London Bankers, England went on, sometime, some decades later, in the middle of the 18th century, to have the Industrial Revolution and an empire around the world, and, some of the bankers who were
in on the financing of that, as we'll see, became art collectors. Now, we, quickly to the United States, Americans, after Independence, were, picked up the banking habit pretty quickly and I think the key person here, a person who I spent a
lot of my time studying is Alexander Hamilton who
we don't give enough credit for his contributions to our country. This is a quote from Hamilton. In 1781, when there was not
any bank in the United States, there had never been a real,
modern bank in the United States. In 1781, Alexander Hamilton
was a lieutenant colonel in the Continental Army, he was only about 24, 25 years old, and, he was the right-hand
man of George Washington, as his aide-de-camp, but he writes in a
letter to Robert Morris, at the time, Morris had become appointed the financier of the
Superintendent of Finance, they called him, of the United States, this was after the continental
currency that they issued basically became valueless, and Morris was brought in
to try to bring some sense of stability to very unstable finances, so Hamilton, always giving
other people advice, writes him a letter. And in that letter he says, the tendency, remember, this is a time when
there has not been a bank in the United States. "The tendency of a national
bank is to increase "public and private credit. "The former gives power to the state, "and the latter facilitates
and extends the operations "of commerce among individuals." Hamilton was interested in building a strong government, and he was interested in
building a strong economy, and he thinks that banks are the key to that. The private credit "industry is increased, "commodities are multiplied, "agriculture and manufacturers flourish, "and herein consists the
true wealth and prosperity "of a state." And then this next paragraph
has what I think is one of my great Hamilton favorite quotes. "Most commercial nations
have found it necessary "to institute banks, and
they have proved to be "the happiest engines
that ever were invented "for advancing trade, "Venice, Genoa, Hamburg, Holland, "and England are examples
of their utility." I teach financial history. Alexander Hamilton obviously
knew his financial history more than most people at that time. About a decade after Hamilton wrote this, he was put in the position
of being our first treasury secretary and he
modernized U.S. finances in just a few years. This is the biggest and
most important story in American history that
you probably never heard much about, but Hamilton's financial modernization, the U.S. went on to become the, the most successful emerging market of the last couple of centuries. And, the Americans not
only latched on to banking, well, actually due to
Hamilton's innovations, but they pushed it to great lengths, and this is from the 1830s. A chap named Roger B.
Taney, who's the secretary of the treasury in the 1830s, some decades later, he's the Chief Justice
of the Supreme Court, and issued the Dred Scott
Decision which was not his most useful thing, but in the 1830s, as Andrew
Jackson's treasury secretary, Taney says, "There is perhaps no business "which yields a profit
so certain and liberal "as the business of banking and exchange, "and it is proper that it
should be open as far as "practicable to most free competition "and its advantages shared
by all classes of society." This was kind of something new. Everybody should have
the right to be a banker, anybody can be a banker. At the time, the U.S.
didn't have zero banks, like it did when Hamilton wrote, it had about four or five hundred banks, and then I go on to point out here, by the early 20th century, 1913, the U.S. had tens
of thousands of banks and roughly 40% of the
entire world's bank deposits. Like the Italians, the Dutch,
and the Brits before them, the Americans parlayed
their banking into economic leadership and great wealth. All right, now here comes
the business school lecture. The, I said in the very beginning that northern Italy pioneered in banking, but they also pioneered in
double-entry bookkeeping. I just read a book lately,
it's kind of interesting because right outside the door, there's this wonderful Piero
della Francesca exhibit, and he was from a town in Italy called Borgo San Sepolcro. Another person from that
town was Luca Pacioli who overlapped with Piero. Pacioli actually, in
his famous book of 1494, called him Pietro di Francesci, and Piero, the artist whose
work is featured outside, was quite a mathematician, and wrote books about mathematics and the perspective of art, you know, I mean his mathematics was directed toward improving art, and some people think that Pacioli learned a lot of math
from the painter, Piero, and he certainly thanked him in his book, but Pacioli's famous chapter sort of codified double-entry bookkeeping which was another northern
Italian innovation, and, double-entry bookkeeping
and a bank balance sheet might look something like this, so here's the, you're all M.B.A.s now. (audience laughs) A balance sheet of a bank has its assets and liabilities. You start in the lower right there, say some investors in the
bank invest some capital in the bank, I'll call it 200 here, it
doesn't matter what the money units are, and they open up the bank to take deposits and pretty soon, people
come in and deposit 800 with them, and you get a total of 1,000 and for the sum of the liabilities, and the net worth, the
capital is the net worth of the bank. How are those assets deployed? Well, over on the other
side, you see they're going to have cash reserves of 100. That's because some of those depositers are going to come in sometime and ask for cash, and take money out of the bank, but of course other people
will be bringing money to the bank so you don't
have to have cash reserves equal to the total of deposits, and in fact, here I've got, what? 800 of deposits and only
100 of cash reserves, but the real fun in banking
comes from making loans and making investments and I've given you some examples. This bank is going to make 700 of loans and 200 of investments, and you add that to the cash reserves and you have 1,000. The books have to balance
in double-entry bookkeeping. Now, I've just made some assumptions about the interest rate earned
by the bank on these lones. It's going to be 8%
and on the investments, it's going to be 6%. They're going to pay 2% to the depositers for the use of their money. Remember, I said that the
first banker, with his bench by the Rialto Bridge in Venice, opened up his books and
he paid money for deposits and also made loans and
charged a higher rate, well, that's what I'm showing here. If you assume those interest rates and the amounts of assets,
you see you're going to earn 56 a year on your loans, you're going to earn 12
a year on your deposits, that gives you a gross income of 68. On the other side, you have to pay out 16, and you're paying 2% on the deposits, so that's going to give you
gross earnings less costs of 52, but then there's some
fixed costs to a bank. I'm just calling them 20 here, and then you end up, in the lower left, with a profit of 32, and when you relate that to the
capital invested in the bank you see the return on capital is 32 over 200, or 16%, and this is the magic and
the mystery of banking. You know, you lend money at 8% or you invest in investments at 6%, but somehow or other in the end, you earn 16% on your own capital. And that's, that's what so fascinates
people about banking. That's why so many, when Roger Taney said every
American ought to be a banker, a lot of him took him up on the idea. All right. Well, that's, this is a pretty good bank, you know, 16% return on capital. But there's some
temptations involved here. How, you know, if you want to think about it, how could you make more money in banking? What would be a good
way to make more money? Well, one way, that we say, you have all that capital there, but if you can get by with less capital, then you might, you know, using the leverage of deposits, you might make a higher return. Another thing is, you might, you know, want to say, well, those cash reserves, they're not earning that much for us, maybe earning nothing. We should take some of those
hundred of cash reserves and put them into investments, so I'm going to come up
with another bank here. Basically, it's the same sort of story, but this bank is now going
to have not 800 of deposits but 900, and that means it's going
to reduce its capital to 100 total assets, or total liabilities are still 1,000. It's going to have the same earnings of, say, 8% on loans and 6% on investments, but now, you're going to
run down the cash reserves from 100 to 50, and you're going to increase
your loans and investments, loans are now going to go to 850, what were they before? 700. And the investments are going to go, well, I got them reduced here, so it doesn't matter that much, but, anyway, now this bank, you know, this is a bank
that's skating a little bit on thin ice. Because it doesn't have so much capital. If somehow the loans and
investments shrink in value, the capital is, you know, gonna be wiped out sooner when it's 100 than it would have been
if the capital were 200. So anyway, this bank now is
going to earn 68 from lending. It's going to earn six on
its hundred of investments, so now the gross earnings, and it's still gonna pay 2%
on the now larger deposits of 900. That's 18. If you, 68 and 6 is 74, minus 18 is gonna be 56, and it still has the fixed cost of 20, so now, by running down the capital and running down the cash reserves, the profit of the bank is 36, but that relates now to a
capital which is only 100, not 200, and suddenly, this bank
is making a 36% return, even greater magic than we saw before, but it's in a much riskier situation because, as I mentioned, if the loans and
investments lose some value, they only have to lose 100 of value, and the bank is wiped out because its capital is only 100. Or, the bank is more
vulnerable to a run now because it only has 50
of the cash reserves against 900 of deposits, instead of 100 of cash reserves against 800 of deposits. Okay. That's your lesson in how to be a banker. Be a safe banker. And how to be a risky banker, and, the quiz comes in 20 minutes. (audience chuckles) All right, what are the
implications of this now? The, to boost the returns on their own capital, banks are tempted to have
less capital invested and to hold smaller reserves, but as I just said, that
increases the risk of default for the reasons I give here. By the way, the leverage
of my first bank was 5:1, sort of assets divided by capital. The second bank, the leverage is 10:1, assets divided by capital, and it's because bankers
have these temptations to reduce their capital in order to magnify their returns, and to hold the small reserves. This is the reason we regulate
banks in the modern world. And we do that, we have deposit insurance, bank regulation, may tell, you know, we have Basel
rules being formed, you know, all the banks of the world, they're supposed to have some rules on how much capital they would have. In the United States, we
have deposit insurance, we have a Central Bank
to protect depositors, because if a perfectly good
bank doesn't have enough reserves, it can borrow some
from the Federal Reserve, which is a bankers' bank. But most of the bankers
we're talking about were back in a time when
we didn't have these modern innovations, and so how did
the bankers last and prosper and get the money to invest in art? Well, I think they were more
like the first bank I showed you, they were prudent. They did not take great chances. And, they were more like my first bank. The second banks were more likely to fail, so these prudent, prudent bankers could prosper over the long run and make a lot of money which they might invest in art. Now, I think most of the bank, I called the previous
bank a commercial bank. Most of the bankers
we're talking about here are what we call investment banks, or in Britain they would
call them merchant banks, and, the balance sheets,
I didn't put numbers here, but, on the liabilities side, instead of having just deposits, I'm calling it funding, and these banks would get their funding maybe from deposits,
but they might sell CDs, they might sell commercial paper, they might get loans from other banks, they might even underwrite some insurance, the Rothschilds did that, and that insurance is a way of, you know, 'cause you pay your premiums now and hope your car doesn't crash or your house doesn't burn down, but when you pay that premium, somebody's got the money and, then they can use that money. Why does Warren Buffett
own insurance companies? Because they generate
a lot of cash for him and he can invest it. He's a smart investor and he likes to own insurance companies because they bring in a lot
of cash for him to invest. On the asset side, it's not just a matter
of loans to business now or investments, but you have government securities, private securities, bills of exchange, which I have to explain
a bill of exchange. You all know what a check is. You write a check. A bill of exchange is just like a check that's not payable right away, but it's payable three months from now or six months from now. It becomes a credit instrument. Wouldn't it be nice if
we could all write checks to people but they wouldn't
be collected for six months? Well, this is where the bankers came in, from the Medici right
down to the present banks, issue these bills, businesses issue bills of exchange, banks buy them, they discount them, earn interest on them, charge fees for them, sometimes they guarantee them. If there's a guarantee
of a bill of exchange, sometimes it's called
the bankers' acceptance, where the bank says, you know, "We guarantee that this will be paid." There's a fee for that. Our bankers may deal in commodities, that's why they're
called merchant bankers. They may have investments
like the Medici Bank did in some manufacturing of cloth and mining and the Rothschilds had investments
in insurance companies, and of course, they have to
have some cash reserves too. Now, the profits of a bank
like this are going to come from the interest they earn, from dividends, from trading, from fees for accepting bills, insurance premiums in excess of the claims paid, and so on. A merchant bank does a
wide variety of businesses. All right. It's still pretty much like the first bank except it has slightly different ways of funding itself and a wider range of assets that it may hold. Our banker/collectors. Most followed the investment
or merchant banking model but some of them combined investment banking with
commercial banking, JP Morgan did that right from the start. Now, most of our bankers are going
to be in the last couple of centuries, and they
had a great advantage that Medici did not have, the unprecedented industrialization and economic growth of the
19th and 20th centuries created great opportunities for bankers that weren't there so
much in the Medici era, but the Medici Bank's
business was not so different from what I just showed you. The Medici Bank, 1397 to 1494, had branches in Italy
and northwestern Europe. It specialized in financing trade. You know, Italy imported
a lot of wool from what would be today's Belgium, or from Britain especially, wove it into fancy cloth in Italy, so that wool had to be
bought in places like England and the low countries and shipped to Italy. There were lots of different
kinds of money then. We didn't have the big nation
states that we have today so there were lots of
places where there were different kinds of money. And the nice thing about
that business for the Medici was, you know, the Catholic church had a ban on usury. You weren't supposed to take any interest. The Medici made a lot of money
by disguising the interest as some sort of exchange fee, you know, when you had a lot of different moneys and I think it was
complex enough so the Pope didn't understand it, and they didn't get in any trouble. They also lent money, it was, you know, to the secular and religious princes. They had some of the accounts, they had a branch in Rome and the Catholic Church had a lot of money in the Medici Bank, so they lent to a religious
prince like the Pope but they also lent money
to secular princes. They traded in commodities, and already mentioned,
they invested in cloth manufacturing and mines. The bank lasted not quite a century. Its decline resulted from,
I think a couple of causes. One was these loans to rulers. That was the risky business, you know, it was mentioned that I wrote a book, co-authored a book called "The
History of Interest Rates," and what these early bankers found out is that businessmen were
much more trustworthy than princes and kings. (audience laughs) That's the truth. I mean, that's really important. They would charge low rates to businessmen whom they trusted, but when they lent money to
the princes and the kings, the princes and kings often
defaulted on their debts and that got the Medici Bank into trouble. They also, you know, were
operating a branch system across Europe. It's not so easy to manage such a thing and so the rulers didn't pay back loans and then sometimes the managers, the branch managers up
in Belgium or London of the Medici Bank would
sort of steal from the bank or not make the, they would make loans to a prince when the Medici said, "Don't do that. "That's dangerous." So they couldn't really
be on top of things in that bank, and finally, as was
mentioned by David I think, the later generations of leaders, after Cosmo, Cosmo was the second one, Giovani was the fathered star of the bank, then there was Piero the third generation and Lorenzo the fourth generation, well Lorenzo for example, he became much more
interested in art and politics than in banking. So, by neglecting the banking, he got himself into trouble and the bank disappeared. He didn't mind the store, you might say, he didn't mind the store. He probably wasn't the
first banker in history to do that, but, now, so we skip those three centuries now, we're coming up to the modern era where there's a lot more going on, a lot more opportunity for bankers, and you come to the Hopes and the Barings. I'm just lumping them together
here because they worked together. These were banks that were both, you know, there might have
been earlier versions of it, but Hopes and Barings were
organized around 1762. At our Museum of American
Finance, that was mentioned, I'm the chairman of the board. We have an exhibit right
now on the 250th anniversary of the Barings Bank, so if you're interested in
learning a little more about them you could come down there. In fact, one of the reasons
I came here today was that, you know, this is an art museum and the bankers are giving a lot of money to art museums. I have a finance museum and the bankers don't
seem to want to give us enough money. (audience laughs) You know, it's much more fashionable to invest the money in
art or something like it, or opera, and, but I'm trying to tell these tycoons that, as you decide how to distribute your golden eggs, don't forget the goose. (laughs) (audience laughs) The financial system that
made it all possible, so the, interestingly enough,
showing you how cosmopolitan Europe was, the Hopes
were Scots merchants, but they banked in Amsterdam. The Barings came from Germany but they banked in London. Hopes Bank, just to give you
a little bit of the history, we mentioned the Monte dei Paschi, Hopes lasted until 1992
and it's now a part of ABN Amro, which is currently owned by the Dutch government
because it had to be bailed out. The Barings lasted from
1762 to 1795 when a trader in Singapore named Nick Leeson broke the bank, in other words, he made bets that turned into, you know, losses that wiped out
the capital of Barings and so the proud Barings Bank in 1995 was bought by ING, a Dutch bank, for the princely sum of one British pound, and assuming a lot of liabilities. But in their heyday, in the
late 18th and 19th centuries, the two banks worked together on deals of which perhaps the most famous, at least on this side of the Atlantic, was the financing of
the Louisiana Purchase. Here is a picture, at long last. (audience chuckles) But it's not the kind of
picture that you would see, this actually does hang in the
Museum of American Finance. I trust it will never
be hanging in the Frick. It is a Louisiana Purchase bond, and it's a $200 bond. It says, "Louisiana 6% stock." "Treasury of the United States." "December 24th, 1803." And you might be able
to read it a little bit, but I'll say it, "Be it
known that there is due from "the United States of America "unto Hope and Company
of Amsterdam Merchants "and Francis Baring and
Company of London Merchants," see, they were not even
referred to as bankers then, they were merchant bankers, but they liked to be termed merchants, so, Barings and the Hopes were
going to take these things or their assignees the sum of $200 bearing interest at 6% per annum from the 20th day of December 1803, inclusively payable in Amsterdam, semiannually, this on the
first days of July and January, and at the rate of $2, 2 gilders and 1/2 of a gilder, current money of Holland per dollar. That means a gilder was about 40 cents. Being stock created by
virtue of an act entitled, an act authorized in
the creation of a stock, to the amount of $11,250,000, for the purpose of carrying into effect the convention of the 30th of April, 1803, between the United States of America and the French Republic, and making provision
for the payment of the same past this 10th day of November, 1803, the principal of which is
payable at the Treasury of the United States by annual
installments of not less than 1/4 part each, the first of which will
commence 15 years after the 21st day of October, 1803. And so on and so on, signed Joseph Nourse,
Register of the U.S. Treasury. This is a Louisiana Purchase bond. In late 1803, one of the Baring boys,
Alexander I think it was, took a whole bunch of these with him, from the United States to Europe and then they sold them to investors, mostly in the Netherlands, and in Great Britain and got money which they paid to Napoleon
to make war (chuckles) on the Netherlands and Britain. (audience laughs) This is why I love financial history. You know, across the ocean,
America doubles in size, Napoleon has a lot of
British and Dutch money to make war on the British and the Dutch and the rest of the people in Europe, and, so that's, you know, and of course I think the French did not, Albert Gallatin once winked and said, "The French did not quite get that "$11 1/4 million because
the bankers took off "some for their charges." Well, one of the clever
things that these bankers did, showing my next slide, this is one that I won't read to you because I am not very good in Dutch, but Henry Hope who's mentioned there, you see, Henry Hope, Hope and Company, anyway, is mentioned, what Henry Hope did a clever thing. He, having gotten those American
securities paying 6%, he resold them and this
is a Dutch security for the same thing, Louisiana stock, but he's selling them so the
investor only gets 5 1/2%. (audience chuckles) And so, you know, this is another
way the bankers made money. Now, you see, interest rates
were sort of high in America 'cause we're growing rapidly and we don't have enough capital, but the Dutch are filthy rich, and so they think 5 1/2% is a good deal, or Hope tells them it is, and so they buy that, but that means Henry
hope is gonna get this 1/2% now. If it was all $11 1/4, 1/2%
would be something like $50,000 a year that Henry Hope would get for not taking much risk at all, as long as the United States paid, he'd get $50,000 a year, every year for the 15 years
these bonds were outstanding, $50,000 in that particular period was worth about $1 million a year, so just by reforming the security and selling it to Dutchmen in a language they could read (audience laughs) he could, he was able to get,
right, the million dollars a year the bankers were willing, to get the million dollars a year, for basically taking that much--