After a year of financial reckoning, historian Michael Moss and Sunday Herald business editor Colin Donald show how the 1878 collapse of the City of Glasgow bank has returned to haunt us.
BY MICHAEL MOSS and COLIN DONALD
ON Tuesday, October 1, 1878, the City of Glasgow Bank announced that its doors would not open for business the next day. For its tens of thousands of customers, and for the business world of the second-richest city of the greatest empire in history, it was the day their world ended.
Early the next morning, a great mass of depositors gathered outside the bank's head office at 21 Virginia Street, now the service entrance of the Argyle Street Marks & Spencer. Glaswegians were at least as shocked by the news as Geordies were at the time of Northern Rock. The difference in the Scottish case was that their life savings really were lost.
In those days, it was the other Scottish banks, not the government, that rushed out soothing statements, and offered immediate advances to City of Glasgow Bank (CGB) customers to shore up confidence. Frantic meetings were held about how to steady the market, and head off a collapse of an otherwise strong local stock market.
There had been rumours about the bank's difficulties, but these were dismissed as market mischief, of the sort that HBOS was to complain about as its own near-collapse approached in September this year.
To universal horror, the rumours turned out to be true. The "overthrow" of this august institution, the Glasgow Herald immediately pronounced, was "one of the most serious commercial disasters which have befallen the community for many years". The Glasgow periodical The Bailie put it more melodramatically: "Ruin, stark, utter ruin, stares every shareholder in the face. Not a loop-hole of escape is left, not a patch of silver lines the cloud of misfortune which lowers over them." They did not know the half of it.
Like the current global financial meltdown, the failure of the City of Glasgow Bank was due to lax regulation and over-exposure to risky financial instruments in the discount market. These were to prove as valueless as today's structured investment vehicles.
Established in 1839, the CGB was a relative newcomer to Scottish banking, when compared with the Bank of Scotland (1695-2008) or the Royal Bank of Scotland (1727-). Analysts assumed it to be "in possession of a large and profitable business", mostly tied to India and Australia, the emerging markets of its day. Its 133-branch network was bigger than its rivals', and in the two months before its collapse, the bank had declared a dividend of 12%.
But unbeknown to shareholders, the bank was chest-deep in risky, unprofitable lending. The story of how it got there proves that prudence and dull caution have been much exaggerated as historical Scottish characteristics.
Nowhere were the troubles of the CGB watched more anxiously than in Australia and New Zealand, where the bank had a large stake in the New Zealand and Australia Land Company (NZALC), a major landowner.
This holding was collateral for the then colossal £2 million-plus advance to James Morton, one of the NZALC's architects. Morton, a Glasgow stationer-turned-speculator, had played on personal ties to the CGB that would shock a modern compliance officer. The Bailie reported with relish how he had risen from humble beginnings to supply the CGB with cheque books and ledgers, before transforming himself into a "full-blown Australian merchant".
The Bailie noted Morton's domineering, sanctimonious and ostentatiously generous character, and his "unedifying" interests in everything from cattle, to brandy, tinned meat to funeral undertaking. Having ducked and dived for 40 years, he was as adept at staying one step ahead as Bernie Madoff.
Now this international octopus of trade stood "indebted to the shareholders at this moment for over two millions of hard cash, while the securities held against this enormous sum are worth no more than half a million of pounds". He was bust, and so was the bank that supported him.
In India, the brothers John "Bombay Jock" Fleming and James Nicol Fleming, sons of a Glasgow merchant, also enjoyed easy credit facilities for their company Smith, Fleming & Co. Not surprisingly, as James was a one-time CGB board member.
They made a fortune cornering cotton stocks during the American civil war supply famine. From the proceeds, the Flemings grabbed huge tracts of reclaimed land around Bombay port.
James, who had become a director of the bank in 1863 and who built himself an ostentatious mansion at Keil in Kintyre, left the board of the bank in 1875, after the manager raised concerns about his business interests. He was right to be worried. By the time of the crash, Smith, Fleming & Co owed the bank almost £1.3m, around £100m in today's money.
Smith, Fleming & Co collapsed within the week of the City of Glasgow Bank's failure, with debts of some £3m, bringing several City and Far East finance houses crashing down with it.
James Nicol Fleming was involved with its investment in the American Racine and Mississippi Railroad, which became the Western Union in 1865. Badly managed, this had proved a poor investment.
But for complicated reasons the bank was unable to extricate itself. As one of its representatives admitted in 1866, a full 12 years before the collapse: "Every step forward makes the bank's position more and more difficult. We are getting deeper and deeper into the mire". Although no further advances were made after 1870, at the time of its collapse, the bank was still owed over £1m (some £80m today). Not a penny of it could be recovered.
Glasgow, engine room of empire and a civic wonder of the world, was to suffer irreparable damage from the collapse. The psychological impact on the city is hard to reconstruct now, but its physical scars are still evident.
Immediately the bank closed its doors, Dr AB McGrigor of lawyers McGrigor Donald, and accountant William Anderson of Kerr, Anderson & Co were asked to investigate by shareholders and creditors.
Within less than three weeks - they did things quicker in those days - they made the "startling disclosure" that the bank had liabilities, equivalent to £500m today, which the 1819 shareholders, not protected by limited liability, were required to meet. This amounted to some £2750 for every £100 worth of stock held.
The travails of the Lloyds "names" of the 1980s might provide a parallel with the devastation. Families were ruined, and only 254 shareholders out of the 1819 remained solvent when the liquidation was complete in October 1882. Committees were formed throughout Scotland to relieve the distress of shareholders and depositors whose cash was frozen.
The directors and secretary of the bank were arrested on October 19, 1878 and charged with fraud. Apart from Lewis Potter, who was "unwell" and who sang hymns while waiting for the police, they were all dragged off to Duke Street Prison - grim predecessor of Barlinnie.
For a sense of the impact of this event, imagine Lord (Dennis) Stevenson or Andy Hornby being packed into police vans. The CGB directors were all gentlemen of high status in Victorian Scotland with many connections to churches and charities, all of which were to suffer.
Never averse to stirring the religious politics that obsessed our forebears, the Glasgow Herald helpfully reminded its readers that the bank's directors were mostly members of the Free Church, the same church that had made such a fuss about improving moral standards in public life.
The bankers' trial in January 1879 at the High Court in Edinburgh was the most sensational since that of Burke and Hare 50 years previously.
Lord Chief Justice Moncreiff, summing up, confessed to perplexity at the "variety of accounts, figures, balances and results" and was "certain the jury must have been as well".
But the judge displayed a shrewd grasp of the intricacies of the transactions and the means by which the bank's balance sheet had been falsified. All the directors were found guilty and sentenced to up to 18 months each.
Although JN Fleming's misguided ventures were found to have played a major part in the bank's demise, because he had ceased to be a director, there was no case against him.
In any case, like Robert Maxwell, he had vanished. Shortly after news of the collapse broke, his yacht slipped its moorings at his home in Kintyre, leaving his creditors to sort out the mess. Had he sailed for Spain or Portugal? Or was he hiding in London? No-one knew for certain.
Fleming was to reappear three years later, and eventually returned to Glasgow. In 1881 he brazenly sought a discharge from his bankruptcy. It didn't work. Fleming served eight months in prison for fraud.
As with most corporate crimes, guilty verdicts and prison sentences achieved their aim of making the victims feel better. In this case, everyone in commercial Scotland was a victim. The knock-on effect of the collapse of the bank was a haemorrhage of confidence in the entire Glasgow financial sector, that saw Edinburgh take precedence as the financial hub. Shares in other Scottish banks plunged.
Nor did this Clyde-built banking crisis stop at the Border. The Bank of England took emergency action by pumping liquidity into the market and accepting bills - the equivalent of the (belated) action that has been taken today. But despite these efforts to maintain confidence, six smaller banks collapsed, including the West of England & South Wales District Bank, and, in January 1879, the London & County Bank stemmed a run on deposits via emergency support from the Bank of England. It was to be the last run on a British bank until Northern Rock in October 2007.
Michael Collins, professor of financial history at Leeds University, describes the CGB's failure as "the most severe UK liquidity crisis of the 19th century". Being a purely commercial disaster, it compares far more closely to today's dire straits than the more often-quoted crisis of the 1930s, which was largely caused by the dislocation of markets by wartime expenditure.
Just like today, the building trade was the first sector to be hit. During the 1870s Glasgow and the west of Scotland had experienced a massive building boom. Many of the terraces and tenement blocks in the city's west end were constructed at the time, along with such notable public landmarks as the Clydesdale Bank head office and Central Station. In those days, only the very rich owned their own houses, but mortgage finance was used extensively by builders to fund the construction of blocks of tenements - a forerunner of the buy-to-let market. Before the collapse there were signs, just like last year, that the housing sector was overheating, but this was to become a rout, with the majority of building firms and their suppliers being forced out of business, including the young Robert McAlpine.
There is evidence of building projects abandoned in the late 1870s or early 1880s because of the difficulty of finding buyers, tenants and credit. The unfinished Kirklee Gardens beside Kelvinside Academy in the west end is a good example. Will evidence of the current crisis still be visible 130 years from now?
Bankruptcies in Scotland were to accelerate rapidly in the last months of 1878, reaching a peak the following year - the largest number in a single year in the entire 19th century. Many businesses simply shut up shop.
Keynesian before Keynes, the Bank of England cut interest rates quite aggressively from 6% in October 1878 to 2% in April 1879.
This Victorian credit crunch took a long time to work through the system, with the recession lasting - ominously enough - for the best part of a decade. There are many reports of creditors being unable to keep up debt repayments.
Then as now, banks became much more risk averse in their lending. When liquidity recovered they preferred the security of government bonds and short-term loans in the money market rather than risking long-term commitment to the private sector, particularly emerging markets.
Amazingly, Scottish house prices did not return to 1870s levels until the late 1950s, although the graph is distorted by two world wars and other global shocks.
Scotland's worst financial cataclysm since the Darien disaster two centuries earlier, was followed by cries for improved regulation - the end of unlimited liability for banks, greater transparency and accountability in the opaque world of banking.
Despite the scale of the disaster, these calls were manfully resisted by the banking community. The situation in Scotland was complicated by the fact that the three oldest banks, the Bank of Scotland, the Royal Bank and the British Linen Bank, were all creations of the state, and all therefore enjoyed limited liability. After fierce debate, Disraeli's Conservative government passed the Banking and Joint Stock Companies Act in 1879, that brought unlimited liability for the banking sector to an end. But it only included very minimal provisions for effective external audit.
The question for today's policy-makers is this: can anything positive be learned from what happened after 1878? Do we have to tough it out as our late Victorian forerunners did? The first lesson must be that there is no short-term fix; the second is to find ways of avoiding a long-term retreat into government bonds.
This will require unpalatable political decisions. Government expenditure will need to be cut sharply. Perhaps the most important lesson is that Gordon Brown's "virtuous circle" of investment for future success was a mirage. The economy tends to move in vicious cycles and all that central banks and governments can do is try to mitigate the damage.
THE COLLAPSE THAT HAUNTED GLASGOW FOR A CENTURY
Glasgow continued to grow long after the City of Glasgow Bank miscreants were released from the squalor of Duke Street Prison, above. The city still had several more decades to go before its industrial eclipse after the first world war. But many historians now believe it was the events of 1878 that caused a slow puncture in its inflated civic pride. Decline mentality, hitherto unheard of, began to creep in.
The major practical shift after the collapse was that the money men drifted away. Glasgow ceased to be a financial as well as an industrial powerhouse, resulting in an unhealthy imbalance.
As Belfast proved more adept at attracting finance for passenger-ship building, the Clyde shipyards came to rely too heavily on naval contracts. The extremity of Glasgow's economic cycles became more pronounced. Industrial boom followed industrial bust and, in good times, military spending crowded out the more sustainable, cutting-edge manufacturing happening elsewhere in the UK. With a few notable exceptions, by the time of the depression of the 1920s and 1930s, the Clyde's entrepreneurial spirit had all but drained away.
Despite a brief revival of heavy industry after the second world war, decline turned to rout in the 1960s and 1970s. When the Glasgow financial economy did revive in the 1990s, it was as a satellite of London and Edinburgh sectors, with cheaper labour. Pessimists fear that the collapse of HBOS and the effective nationalisation of RBS will cast as long a shadow over Scotland's economy as this mid-Victorian financial cataclysm on the Clyde.
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