Lessons from the Crash of 1882

Working paper of the day- The Crash of 1882, Counterparty Risk, and the Bailout of the Paris Bourse by Eugene N. White

“The rapid growth of derivative markets has raised concerns about counterparty risk. It has been argued that their mutual guarantee funds provide an adequate safety net. While this mutualization of risk protects clients and brokers from idiosyncratic shocks, it is generally assumed that it also offers protection against systemic shocks, largely based on the observation that no twentieth century exchange has been forced to shut down. However, an important exception occurred in 1882 when the crash of the French stock market nearly forced the closure of the Paris Bourse. This exchange's structure was very similar to today's futures markets, with a dominant forward market leading the Bourse to adopt a common fund to guarantee transactions. Using new archival data, this paper shows how the crash overwhelmed the Bourse's common fund. Only an emergency loan from the Bank of France, intermediated by the largest banks, prevented a closure of the Bourse.”

Excerpt from the conclusion;

“The Paris Bourse just avoided a complete collapse in 1882. The general decline in the market ruined many traders and, in turn, destroyed some brokers, weakening the rest. Not only was the margin demanded of clients insufficient to cover losses from the crash, but the common fund was exhausted and no quick assessment of the solvent brokers was possible. Thus the worst case scenario for contemporary futures markets was played out on Europe’s second largest exchange in 1882. Fortunately, the Bank of France recognized the danger of an expanding liquidity crisis and step in to provide credit to the market, acting appropriately as the “insurer of last resort.” The Bank of France was careful to distinguish this shock as a systemic one, compared to the crash of the gold stocks, where losses did not threaten the liquidity of the financial system and hence did not require intervention. Its prompt action in 1882 may have limited contagion from the crash, explaining why it did not reverberate more strongly beyond France’s borders.”

*The Chart above from NYT- Wall St. Tumble Adds to Worries About Economies

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