Bagehot’s giant bubble failure

Modern economic history literature has extensive coverage of the Overend, Gurney crash of 1866 and the associated Lender of Last Resort operations of the Bank of England. But it basically ignores the giant British investment mania of the 1860s that led to that crisis and to the crisis of 1867 that followed. Yet that mania has many other interesting features that are relevant for dealing with bubbles. In particular, that historical episode shows that high interest rates may not suffice to deflate a bubble. It also demonstrates the dangers of “financial innovation,” which flowered in that period and enabled promoters to mislead and ruin investors in novel ways, while producing a rapid expansion of the railway system that escaped public notice. Even some of the most sophisticated contemporary observers, such as Walter Bagehot, who were bothered by the market anomalies they saw, were deceived by that pioneering “financial engineering” which has strong similarities to the one that led to the Global Financial Crisis of 2008. This paper points out some of the many neglected aspects of that mania. Those include an illustration of the evolution of economic thought towards ignoring underlying causes of financial crises and concentrating just on the panics in which they culminate.