• FIC Hansraj

The Credit Crisis of 1772

Prelude


During the 17th and 18th centuries, Great Britain followed a clearly expansionist regime of spreading its administrative stronghold over various regions and territories across the world by annexing many regions which later came to be known as its colonies. Much of Britain's colonies were reeling in an abysmal financial state.


Credit Crisis 1772 | FIC Hansraj
Credit Crisis

Starved from the capital, underdeveloped financial institutions and poor development metrics paved cheap credit from Britain to flow into these colonies for undertaking investment in development activities. With capital scarce in the American Colonies, colonial planters were eager to borrow cheap capital from British creditors. But because planters often maintained open lines of credit through multiple trade channels, creditors had no way of knowing a particular planter’s indebtedness. Economic growth at that period was highly dependent on the use of credit, which was largely based upon people’s confidence in the banks. As confidence started ebbing, paralysis of the credit system followed: crowds of people gathered at the banks and requested debt repayment or attempted to withdraw their deposits. So when two banks in London failed, contagion spread and the credit boom suddenly met its end.


Crisis struck the market


The credit crisis of 1772 began in June with the closing of two London banks. As bankruptcies rose in London, the contagion spread across England and Scotland, and then on to Dutch banks, before existing central banks calmed the markets. The credit boom came to an abrupt end, and the ensuing crisis harmed the East India Trading Company, the West Indies in general, and the North American colonial planters specifically. In the western colonies, planters struggled to repay British merchants as consumers couldn't offer remunerative prices for their products. Bills of exchange became untrustworthy and States like Virginia had to cheap sell their tobacco produce to meet creditors' requirements. Given the falling commodity prices and creditor uncertainty over each planter’s indebtedness, credit became further constrained and difficult to obtain.


The law of fractionalization and division in mortgage services further worsened the problem. With heightened structuring and regulations following the failure of the aforementioned banks, the originate-to-distribute model failed as banks governed by federal agencies became more particular and skeptical about giving loans.


The immediate aftermath of the Crisis: Sparking the American revolution


The Credit Crisis of 1772 | FIC Hansraj
Credit Crisis

After the crisis, a dramatic rise in the number of bankruptcies was observed: the average number of bankruptcies in London was 310 from 1764–71, but the number rose to 484 in 1772 and 556 in 1773. Banks that were deeply involved in speculation endured hard times during the crisis. The East India Company bore heavy losses and its stock price fell significantly. As Dutch banking houses had invested extensively in the stock of the East India Company, they suffered the loss along with the other shareholders. After the crisis, the flexibility and resilience that the system previously exhibited most notably in 1756 and 1763 had substantially diminished. Thus on one hand where there were macroprudential motivations for Scotland's largest bank to lobby for regulatory intervention, the unintended second and third-order effects were no less on account of some noble intentions.



After the outbreak of the crisis, British merchants urgently called for repayment of debt and American planters faced the serious problem of how to pay the debt for several reasons. First, because of the economic boom before the crisis, planters were not prepared for large-scale debt liquidation thus leading to equivocal liquidity maintenance. As the credit system broke down, bills of exchange were rejected, not trusted upon, and almost all heavy gold was sent to Britain. Second, without the support of the credit, planters were unable to continue producing and selling their goods. Since the whole market was dilapidated, the fallen price of their goods also intensified the pressure on planters. Distressed by the turn of events, this is what gave rise to what we call the modern-day "American Revolution".