The Crisis of 1763 Liquidity and Contagion
Abstract (via hyunsongshin.org)
The financial crisis that swept across northern Europe in 1763 bears a strong resemblance to more recent episodes of financial distress. The combination of the specific contractual arrangements at the time, interlocking credit relationships and the high leverage of market participants triggered distress sales of assets, leading into a severe liquidity crisis. Hence, the crisis is an early instance of contagion on the asset side of the balance sheet. We highlight the salient features of the 1763 crisis and propose a stylized mode of the events. Whilst the financial institutions have changed fundamentally in the intervening two hundred or so years the underlying problems appear to be universal.
Introduction (Via Hyunsongshin.org)
At the end of the Seven Years’ War, the whole of northern Europe was gripped by a financial crisis that has been described by one commentator as “a pest epidemic, spreading with raving speed from house to house”1. Although the institutions governing financial markets looked very different in 1763 compared to those today, the crisis shows many features that would be familiar to an observer of recent financial crises. Indeed, many of the hotly debated topics of the last few years, such as the role of highly leveraged institutions, liquidity drains in times of crisis, and the intertwining of credit risk and market risk, are clearly evident in 1763. We see financial innovations that allowed nimble market players to increase leverage in a buoyant financial market and amass rapid gains at the expense of increased fragility of the system. We see these same players finally breaking down, inducing fire sales of assets and widespread failures, with severe repercussions for all market participants and the economy as a whole. In contrast to other historical episodes, the events of 1763 have received surprisingly little attention, even though they might be considered key to a better understanding of more recent events.