The document discusses the economic depression of 1893 in the United States, comparing the economic conditions of that period to the late 19th century, including high agricultural production and debt levels among farmers that led to falling prices and widespread foreclosures when the economy declined. It also describes the panic of 1893 that triggered the depression, the international impacts, and the political and social responses, as well as how the economy eventually recovered but looked quite different by the late 1890s with new industries on the rise.

1. 1Impact Winter 2011 Edition
Ryan & Coppola Law Firm, LLC Investor’s Guide
Lessons from the Depression of 1893
silver political crusades, the creation of a new
A s the U.S. and the global economy continue political balance, the continuing transformation of the
to stabilize their financial systems, as the country's economy, major changes in national policy,
markets begin to record significant profits and far-reaching social and intellectual developments.
from a broad range of businesses, we see that CEO’s, Business contraction shaped the decade that ushered
politicians, banks and consumers still stubbornly out the nineteenth century.
remain in a locked or stagnant position.
The depression struck an economy that was more like
We continue to watch for solid upward trends in the the economy of 1993 than that of 1793. By 1890, the
economy, stock market, residential and commercial US economy generated one of the highest levels of
property, and new century jobs to replace the old output per person in the world -- below that in
century jobs. Continuing to learn from historic Britain, but higher than the rest of Europe.
parallels, I discovered a report from a previous Agriculture no longer dominated the economy,
financial crisis that led to recession and global producing only about 19 percent of GNP, well below
depression. While I remain convinced we are slowly the 30 percent produced in manufacturing and
moving into a more active and positive economy, it mining. Agriculture's share of the labor force, which
behooves us to learn from past experience. had been about 74% in 1800, and 60% in 1860, had
fallen to roughly 40% in 1890. Only the South
You will notice striking similarities between the remained a predominantly agricultural region.
1893-1897 period and our current 2008- ? period. Throughout the country few families were self-
To compare these century transitions, following are sufficient, most relied on selling their output or labor
excerpts of a brilliantly constructed paper by David in the market -- unlike those living in the country one
O. Whitten, a professor at Auburn University: hundred years earlier.
Between 1870 and 1890 the number of farms in the
The Depression of 1893 was one of the worst in United States rose by nearly 80 percent, to 4.5
American history with the unemployment rate million, and increased by another 25 percent by the
exceeding ten percent for half a decade. This article end of the century. Farm property value grew by 75
describes economic developments in the decades percent, to $16.5 billion, and by 1900 had increased
leading up to the depression; the performance of the by another 25 percent. The advancing checkerboard
economy during the 1890s; domestic and of tilled fields in the nation's heartland represented a
international causes of the depression; and political vast indebtedness. Nationwide about 29% of farmers
and social responses to the depression. were encumbered by mortgages. One contemporary
observer estimated 2.3 million farm mortgages
The Depression of 1893 can be seen as a watershed
nationwide in 1890 worth over $2.2 billion. But
event in American history. It was accompanied by
farmers in the plains were much more likely to be in
violent strikes, the climax of the Populist and free

2. debt. Kansas croplands were mortgaged to 45 percent The great banking house of Baring and Brothers,
of their true value, those in South Dakota to 46 caught with excessive holdings of Argentine
percent, in Minnesota to 44, in Montana 41, and in securities in a falling market, shocked the financial
Colorado 34 percent. Debt covered a comparable world by suspending business on November 20,
proportion of all farmlands in those states. Under 1890. Within a year of the crisis, commercial
favorable conditions the millions of dollars of annual stagnation had settled over most of Europe. The
charges on farm mortgages could be borne, but a contraction was severe and long-lived.
declining economy brought foreclosures and tax Panic in the United Kingdom and falling trade in
sales. Europe brought serious repercussions in the United
The output of staples skyrocketed. Yields of wheat, States. The immediate result was near panic in New
corn, and cotton doubled between 1870 and 1890 York City, the nation's financial center, as British
though the nation's population rose by only two- investors sold their American stocks to obtain funds.
thirds. Grain and fiber flooded the domestic market. restricted investment, income, and profits spelled low
Moreover, competition in world markets was fierce: consumption, widespread suffering, and occasionally
Egypt and India emerged as rival sources of cotton; explosive labor and political struggles. An extensive
other areas poured out a growing stream of cereals. but incomplete revival occurred in 1895.
Farmers in the United States read the disappointing
results in falling prices. Over 1870-73, corn and Only in mid-1897 did recovery begin in this country;
wheat averaged $0.463 and $1.174 per bushel and full prosperity returned gradually over the ensuing
cotton $0.152 per pound; twenty years later they year and more.
brought but $0.412 and $0.707 a bushel and $0.078 a
pound. In 1889 corn fell to ten cents in Kansas, about The economy that emerged from the depression
half the estimated cost of production. Some farmers differed profoundly from that of 1893. Consolidation
in need of cash to meet debts tried to increase income and the influence of investment bankers were more
by increasing output of crops whose overproduction advanced. The nation's international trade position
had already demoralized prices and cut farm receipts. was more advantageous: huge merchandise exports
assured a positive net balance of payments despite
The depression, which was signaled by a financial large tourist expenditures abroad, foreign investments
panic in 1893, has been blamed on the deflation in the United States, and a continued reliance on
dating back to the Civil War, the gold standard and foreign shipping to carry most of America's overseas
monetary policy, underconsumption (the economy commerce. Moreover, new industries were rapidly
was producing goods and services at a higher rate moving to ascendancy, and manufactures were
than society was consuming and the resulting coming to replace farm produce as the staple products
inventory accumulation led firms to reduce and exports of the country. The era revealed the
employment and cut back production), a general outlines of an emerging industrial-urban economic
economic unsoundness (a reference less to tangible order that portended great changes for the United
economic difficulties and more to a feeling that the States.
economy was not running properly), and government
extravagance
Both output and consumption of farm equipment
began to fall as early as 1891, marking a decline in
agricultural investment. Moreover, foreclosure of
farm mortgages reduced the ability of mortgage
companies, banks, and other lenders to convert their
earning assets into cash because the willingness of
investors to buy mortgage paper was reduced by the
declining expectation that they would yield a positive
return.

3. Nevada are in negative equity (see map). Yet the
problem is national. One in four American borrowers
are under water. Over 4m households owe at least
twice as much as their home is worth.
Impact Top Stocks for 2010 (Global)
Company Quote 1-1-09 12-01-10 Such inundations have nasty effects. Homeowners
Price Price that are reluctant to default but unable to sell at a loss
GE GE 12.90 16.16 are left stuck where they are. This throws sand in the
Lafarge LFRGY 11.95 15.03 gears of America’s famously fluid labour market. A
Pfizer PFE 17.11 16.82 recent IMF paper attributes 0.5 to 1.25 percentage
MBIA* MBIA 3.08 10.92 points of America’s unemployment rate to this factor.
BB&T BBT 19.81 24.78 Defaults may be an even bigger problem. Job losses
AES AES 8.04 11.45 will often push underwater borrowers into default
Dupont DD 23.53 46.46 since a sale isn’t a realistic option. And as the crisis
Arch Coal* ACI 15.45 28.96 has dragged on, more Americans have defaulted
PetroBrasil PBR 23.78 33.78 voluntarily. Estimates from 2009 suggest that 26% of
FndtnCoal FCL 15.16 47.63 ** defaults were “strategic” in nature; where equity has
Iron Mtn IRM 22.04 22.94 fallen below 50% of the loan’s value, around half of
*Author owns stock shares. defaults are strategic.
**Acquired by ANR in stock swap 5-09 @
$32.73. The resulting foreclosures cause lots of damage.
Underwater borrowers who sell their home typically
get a price 13% below the mortgage value. When
Drowning or waiving homes are foreclosed upon and sold by lenders, the
The policy options for alleviating America’s huge discount rises to 35%, largely because the property is
negative-equity problem not being maintained. This steep drop in price harms
other homeowners. The values of neighbouring
houses are pushed down, forcing other borrowers
deeper under water.
Since lenders bear the brunt of the higher losses that
foreclosure entails, their general reluctance to modify
the balance of mortgage loans is puzzling. If
mortgages could be written down to a value above the
likely foreclosure sale price, that would generate
benefits for both creditor and borrower. Yet a report
earlier this year into the government’s foreclosure-
prevention programme showed that principal was
forgiven in only 2% of cases. So what is preventing a
better outcome?
AMERICA’S south-west may be a very dry place but Loan servicers, which manage loans on behalf of
nowhere else in the country are more homeowners investors in mortgage-backed securities, may fear
“under water”, owing more on their mortgages than lawsuits alleging that borrowers have been treated too
their homes are worth. In cities like Phoenix and Las generously. Writing down loan values often affects
Vegas prices have fallen by up to 50% from their more than one lender—second, third and even fourth
peak; more than half the mortgages in Arizona and mortgages were common during the housing boom.
Banks are wary of moral hazard: if word spreads,

4. borrowers with the ability to pay their mortgage may
deliberately miss payments in order to get their loans Submerged acquisitions
adjusted.
Eric Posner and Luigi Zingales of the University of
This last problem can be addressed by changing Chicago have proposed a plan whereby an
borrowers’ incentives to default. Contingent write- underwater homeowner living in a postcode area
downs are one example: loans would be written down which has suffered a certain level of price decline
in increments over three years, but only if the gets the right to approach a judge and begin
borrower stayed current on payments. Another is a negotiating a write-down. The pain of bankruptcy
“shared appreciation” scheme in which principal should deter opportunists; judges would foreclose on
reductions are combined with an equity stake for those who cannot afford even a smaller mortgage.
lenders. Equity gains from subsequent price increases The big drawback is that this would damage
would be split between homeowners and lenders creditors’ rights. To make the outcome fairer for
upon sale of the home. lenders Messrs Posner and Zingales propose a shared-
appreciation scheme.
Whether such ideas would prompt many more write-
downs is unclear. They do not address the problem of More ambitious still is the “right to rent” programme
multiple claims on the same underlying assets, for advocated by, among others, Dean Baker of the
instance: that would probably require banks holding Centre for Economic and Policy Research. Mr Baker
junior liens to take a more realistic view of their would give defaulting borrowers the option to rent
value and write them down. They also bump up their homes at market rates. The bank would obtain
against the complexities of modifying securitised the whole of the equity stake in the house; with rental
loans. John Geanakoplos, an economist at Yale, income still flowing in, sale of the property could be
proposes that this problem be addressed by adopting delayed until markets were healthier. Critics point out
legislation that strips the responsibility for that property management is not a core skill of banks,
modifications from servicers and hands it to “blind” but the job could be outsourced.
government-appointed trustees who would make
decisions without knowledge of the loans’ status. Mr There is another way. In the 1990s Mexico cleaned
Geanakoplos reckons this would address the up its debt crisis by offering large government
incentive problems and legal issues faced by subsidies, of up to 60% of a loan’s book value, to
servicers, which often have fiduciary duties to help pay down borrowers’ debts. Such a programme
holders of mortgage securities. would not come cheap—America has some $766
billion in negative-equity debt—but it would have the
A measure called lien-stripping, or, more commonly, distinct advantage of simplicity. The unfortunate truth
“cramdown”, offers another way around the is that there are no nice options left. Large-scale
securitisation bottleneck. This would tweak the voluntary write-downs look unlikely—they surely
existing bankruptcy provision known as Chapter 13 would have happened by now. That leaves a choice
to allow judges to write down the value of a primary between twisting lenders’ arms, throwing public
mortgage. Cramdown is already allowed for other money at the issue, or letting the waters close over
forms of consumer debt, such as mortgages on people’s heads.
holiday homes. Research examining the impact of
cramdown on agricultural loans found that banks The Economist 10-21-2010
usually got more than foreclosure value on
reorganised loans, and that interest rates scarcely Is the mortgage market finally coming back?
rose. At the same time the possibility of a principal The answer is important, because the housing
write-down in bankruptcy made banks more willing inventory won't shrink until more people are able to
to negotiate reductions pre-emptively. qualify for loans. Here are 3 reasons for optimism.

5. After more than two years of misery in the housing mortgage market. Today, they're about a 6% sliver.
market, the worst may finally be over. A handful of But private lenders are getting back into the jumbo
recent developments in the mortgage market all point market. These supersize loans were up 3% from
to an easing of lending standards, which have been January to May, according to the most recent data
onerously high since 2008. available from CoreLogic, a mortgage data company.
Wells Fargo almost doubled its jumbo lending, to
Private lenders and the federal government have $3.7 billion, in the second quarter, compared with a
reinvigorated the jumbo mortgage market, making year ago, and Chase was up 16% for the same period
bigger loans more available to more borrowers. And with plans to keep growing.
in general, a would-be homeowner can now qualify The sheer size of these loans suggests more risk for
for a loan with lower credit scores and make a the lender. (If the borrower defaults, the lender could
smaller down payment -- in some cases, as low as take a bigger hit.) But for the high-quality borrower,
5%. Those moves, taken together, mean that more it is a risk the banks now seem willing to take, says
borrowers have access to mortgages, a necessary Keith Gumbinger, a vice president at HSH
precondition for housing to rebound. Associates, a mortgage data tracking company. If
"When you see those moves on the upswing, it gives foreclosures are low, private lenders are likely to
you a hint of what's coming later on," says Chip extend jumbo mortgages to a broader group of
Cummings, the president of Northwind Financial in borrowers in the next year or so. Meanwhile, smaller
Grand Rapids, Mich., a consulting firm for mortgage local lenders have also gotten into the market,
and real-estate companies. Cummings says.
For better borrowers, this means more options. A
Many homebuyers can't get best rates
Fannie- or Freddie-backed mortgage can go up to
Of course, these are only the first signs of what could $729,750, but private lenders can go higher when
be a very long recovery. So far, the changes in the they keep the loan on their books -- an advantage for
private lending market are aimed strictly at the best someone house hunting in expensive cities such as
loan applicants, those with credit scores of 700 or New York, Boston or Washington (and a potential
higher. Riskier borrowers are still undesirable in the boon for those housing markets overall). Interest rates
eyes of the banks -- even the Federal Housing
on jumbo mortgages backed by private lenders are
Administration has raised the floor on credit scores
for prospective applicants. about 1 percentage point higher than those backed by
And without a drop in unemployment and other the government.
economic improvements, demand for the new 2. Smaller down payments
As a consequence of the mortgage meltdown, even
mortgages may not keep pace with supply. But the
qualified borrowers found themselves scrambling to
moves do suggest that lenders, at least, are more make hefty down payments -- commonly 20% or
willing -- and the easier it is to get a loan, the easier it more. But over the past year, that threshold has
is to get a house. dropped, making mortgages more available to people
Here's a closer look at the three changes: with less available cash.
1. More jumbo mortgages For new mortgages, the average loan-to-value ratio --
Before 2007, jumbo mortgages -- any loan over how much people borrow relative to the appraised
$417,000 in average markets -- made up 22% of the value of their house -- has been slowly increasing, a

6. sign that buyers are financing bigger proportions of crash - had those insights only been heeded.
the purchase prices. But Mandelbrot - for all his stock market genius - has
Of course, the no-money-down days are unlikely to been largely ignored by Wall Street.
return anytime soon. As of May, borrowers were still
putting down 28% of the purchase price on average -- As investors, let's not make the same mistake.
still substantial but also significantly less than the
34% down payment they made the year before,
Modern Financial Tomfoolery
according to CoreLogic. And that's going to continue
Back in 1962, the "Modern Finance" revolution was
to drop, says Scott Stern, the CEO of Lenders One, a just getting started, but its theories already had an
mortgage banker cooperative, as more 10%-down iron grip at the University of Chicago, Carnegie-
loans become available. Mellon and other centers of quantitative finance.
"They've been increasing in availability within the
Franco Modigliani and Merton Miller had already
past six months, and we expect continued loosening," unveiled the Modigliani-Miller Theorem (MMM), in
he says. which the two authors argue that companies should
3. Lower credit scores leverage themselves as much as possible because of
Similarly, a borrower's credit no longer needs to be the tax advantages offered by high levels of debt.
spotless in order to get a loan. The requirements are
Harry Markovitz had already offered up his Modern
still high but seem to be creeping down: In May, the Portfolio Theory (MPT), which holds that you should
average borrower's credit score stood at 757, 8 points spread your risk as much as possible, rather than
lower than the year before. But even borrowers with trying to find the best investments. Eugene Fama's
scores in the mid- to high 600s can qualify for a Efficient Market Hypothesis (EMH) was still three
mortgage these days, Stern says. "As recently as a years in the future.
year ago, that credit was almost unavailable."
But all the modern financial theories rested on the
All these changes, small as they may be, indicate that same underlying assumption, that market prices
mortgage lenders are willing to take on more risk and moved in a "random walk," so that their movements
test the boundaries of what makes a high-quality could be measured through a Gaussian/normal
distribution. This was important because the Gaussian
borrower. And as the appetite for lending increases, distribution has very thin "tails" - in other words, the
more applicants could qualify -- a good sign the chances of a price move 10 or 20 times the normal
housing market is moving in the right direction. daily move was vanishingly small.
AnnaMaria Andriotis for SmartMoney. Mandelbrot went to the trouble of actually measuring
Published Oct. 25, 2010 the behavior of market prices (with no data services
and primitive computers, this was much more work
What We Can Learn From The Stock Market than it would be today). His study covered cotton
Genius That Wall Street Loves to Ignore prices, for which a century-long data series already
existed.
Mathematician Benoit B. Mandelbrot, the inventor of
fractal geometry, died Oct. 14. He discovered that price movements did follow a
normal ("bell curve") distribution - and noted that big
As mathematicians go, Mandelbrot was very likely jumps were far more common than the Gaussian
the best of the last half-century. And that brilliance theory dictated. In technical terms, cotton prices
extended to the financial markets. In fact, his obeyed a Pareto-Levy distribution with "alpha" of 1.7
groundbreaking insights into the operations of the - instead of the bell-curve alpha of 2.0.
stock market could have been used to avert the 2008

7. Mandelbrot got no thanks from the Modern Finance spurious assumption that you could control risk by
guys. While seven of them went on to win Nobel looking only at the modest market moves occurring
prizes, Mandelbrot's job offer from the University of on 99% of days - without worrying about the much-
Chicago was rescinded. The poor chap had to go and larger jumps that Mandelbrot had proved would
work for an industrial research operation ... at button- happen on the remaining 1% of trading days.
down International Business Machines Corp. (NYSE:
IBM), no less. He was actually 75 before he got his As early as 1998, events proved that this theorem
first tenured academic position - at Yale in 1999. didn't work right, either. But this didn't stop Wall
Street from using it, because it allowed firms to take
Being a productive guy, Mandelbrot went on to on more-profitable leverage.
invent fractal geometry, which gave him other
insights into market behavior, notably that market In 2004, Mandelbrot updated his theories with the
movements are "self-similar" and "scalable." In other book "The (Mis)Behavior of Markets," using it as an
words, the price movements that take place over the opportunity to provide all kinds of data on how
period of several minutes will resemble price markets really worked.
movements that take place over the period of several
years. It was voted "Best Business Book of the Year."
Mandelbrot's 1982 magnum opus - "The Fractal And it was ignored by Wall Street.
Geometry of Nature" - contained a defiant chapter on
how stock markets failed to behave as the theorists Wall Street was making too much money gambling
claimed. with other people's capital. Institutions didn't want to
hear about anything that might persuade customers to
In theory, for instance, big market crashes should question their beliefs or their methods.
never happen. That's because the "tails" in a bell-
curve distribution are so thin, meaning the probability The crash came in 2008, just as Mandelbrot had
of such a market collapse should be infinitesimal. forecast. The options-valuation models assessing
credit-default swaps proved hopelessly wrong and the
As we all know, however, that's just not the case. In Value-at-Risk models assessing overall risk pushed
fact, according to Mandelbrot, a market crash should several of their users into bankruptcy. Inevitably,
occur about once a decade. taxpayers were called in to bail out the misguided
traders and risk managers - the ones, at least, that
Given the fact that we've had major crashes in 1987, hadn't had the misfortune of being teamed with
1998 and 2008 - roughly once a decade - it's clear Lehman Brothers Holdings (PINK: LEHMQ).
that Mandelbrot made a pretty good prediction.
What's more alarming is that in the thousands of
Meanwhile, the Nobel Prize-winning Modern pages of legislation and regulations that have been
Finance theorists want on invent stuff that written since the crash, very little attention has been
Mandelbrot had already proved to be completely paid to Mandelbrot's work.
wrong.
It's no use raising capital requirements and
For instance, the 1973 Black-Scholes options- toughening up risk-management standards if the
valuation equation was nonsense - it grossly underlying methodology remains hopelessly flawed.
undervalued "out-of-the-money" options, and traders Doubling the capital cushion won't do it - even at that
had to fix it with a completely imaginary options- level, the cushion remains woefully inadequate for
valuation "smile." some of the risks that have become more prevalent in
the markets of today.
The 1990-93 "Value-at-Risk" (VaR) risk-
management system - beloved by Wall Street during For credit-default swaps, for instance, the capital
the 15-year span from 1993-2008 - rested on the cushion should actually be multiplied by 50 - or even

8. 100.
Not surprisingly, that's not happening.
And that means we will be getting another crash. This
time around, however, Mandelbrot's prognosticative
timing may be off: You can bet the next financial
reckoning will arrive long before 2018.
But until Mandelbrot's wisdom is embraced by the
traders, risk-managers, regulators and other
institutions that we refer to as "Wall Street," another
crash is inevitable.
As I said, Mandelbrot was the best mathematician of
the last 50 years. "The (Mis)Behavior of Markets" is
essential reading if you're at all math-tolerant. Even
without it, we can learn from him.
And that puts us a good couple of steps ahead of Wall
Street - which hasn't bothered to do so.
Martin Hutchinson, Contributing Editor,
Money Morning 10-20-2010
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are as of the date of publication, are subject to change, and
may not reflect the views of the firm as a whole. The views
expressed in the commentaries are at a specific point in
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Information discussed should not be considered a
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