(I posted this when it first came out in the middle of 2007. Talk about
premonition.)
NY Times Magazine, August 19, 2007
Idea Lab
Counterfeit Nation
By STEPHEN MIHM
(Stephen Mihm is the author of “A Nation of Counterfeiters: Capitalists,
Con Men and the Making of the United States,” which will be published
next month by Harvard University Press. He teaches history at the
University of Georgia.)
America’s reliance on dubious credit goes all the way back to the
country’s founding.
The recent rumbles and ruptures in the financial markets are finally
making people reassess the dubious systems of credit that have arisen in
the past few years. In retrospect, it seems clear that honest,
tried-and-true ways of borrowing money were recklessly abandoned and
replaced by financial legerdemain: black-box transactions, synthetic
collateralized debt obligations, mezzanine tranches and credit-default
swaps — to cite just a few of the exotically named financial instruments
now facing scrutiny. America’s once-solid economy became a house of
cards, a web of debt masquerading as wealth, a system crying out for
correction. As one Wall Street banker quoted by The Financial Times
concluded, the recent credit crunch suggests that things are finally
“returning to a more ‘normal’ level after ‘abnormally’ loose conditions
over the past few years.”
But what if the last few years of playing fast and loose with credit
were not a deviation from the norm but a return to America’s economic
roots? Though it is hardly the sort of thing you read about in heroic
histories of America’s rise to economic greatness, the credit system in
the United States has often been, in effect, a confidence game writ
large, relying heavily on shaky paper promises, shell games and other
trickery. The standard account would have you believe that the road to
individual and national wealth was paved by hard-working, honest
entrepreneurs who steered clear of get-rich-quick schemes,
counterfeiters’ printing presses and suckers’ swindles. But for better
and for worse, such shady institutions lie at the heart of the country’s
moneymaking past and, if recent events are any indication, its present.
The very phrase “making money” had a curiously literal meaning in the
years between the founding of the United States and the onset of the
Civil War. Throughout that era — a time before the federal government
issued its own, exclusive paper money — hundreds and eventually
thousands of individual banks extended credit and conducted business by
printing and circulating their own “bank notes” in denominations and
designs of their choosing. Unlike today’s currency, bank notes were
promises to pay, not cool, hard cash. A bank issuing a note vowed to pay
the stated amount in “real” money (gold or silver coin) if someone
presented it for redemption at the bank’s counter — a promise that many
banks failed to keep in times of panic. These slips of paper became the
nation’s de facto money supply, as well as the building blocks of the
country’s credit system.
None of this sat well with an earlier generation of credit skeptics.
John Adams, the former president, wrote in 1809 that “every dollar of a
bank bill that is issued beyond the quantity of silver and gold in the
vaults represents nothing and is therefore a cheat upon somebody.” But
Adams, you might argue, was missing an important point: credit is by
definition a contradictory creature. It depends on trust and confidence
and yet invites the possibility of fraud or, at the very least, grave
disappointment. In some deep, unsettling sense, credit depends on
credulousness. Or to put the matter differently, credit depends on
promises — and promises, as the saying goes, are made to be broken.
Broken promises came in many forms in that era of bewildering bank
notes. Reputable banks often failed to meet their commitments in moments
of panic or contraction. Even when times were good, some high-flying
banks lent too many notes on the basis of too little capital and went
under. More cynically, there were so-called wildcat banks, institutions
deliberately founded in remote locations so as to frustrate the
redemption of their notes. And most cynically, a thriving class of
counterfeiters fed on the banking system. Sometimes they copied an
existing bank’s notes; other times, they took the logical next step and,
like the bankers they imitated, established their own banks with
plausible-sounding names, the notes of which they would pass as the
genuine article — which in a sense they were.
All these moneymaking operations blurred the line between what was
counterfeit and genuine. As the financial writer Hezekiah Niles observed
in 1818, there was no real difference “between a set of bank directors,
who make and issue notes . . . which they deliberately promise to pay
with a previous resolution not to pay, and a gang of fair, open, honest
counterfeiters.”
Niles was not merely being rhetorical. The erosion of the boundary
between counterfeit and genuine currency was a day-to-day reality for
everyone who handled money. There was no better symbol of this than the
ubiquitous “counterfeit detectors” found on the desks and counters of
merchants, bankers and storekeepers. These flimsy pamphlets, new
versions of which were published every week or month, claimed to list
every bank note in circulation, along with the rates of discount, known
counterfeits, rumors of fraud and instability and difficult-to-decipher
descriptions of the appearance of each and every note. When bank notes
changed hands, both parties would generally huddle over a “detector.”
After several minutes, a note might be declared genuine, counterfeit or
merely dubious, in which case a discount might be levied. Yet often a
bogus note was accepted with a knowing wink. As one detective would
later recall, “It was a popular remark among men of business at that
time, that they preferred a good counterfeit on a solid bank to any
genuine bill upon the ‘shyster’ institutions.”
For all the fraud, the system worked. Between the Revolution and the
Civil War, the nation’s economy grew by leaps and bounds. The invidious
comparisons between bankers and counterfeiters, though true, hinted at a
still-deeper truth: America’s citizens desperately needed and wanted
money to realize their ambitions, and where the reputable banks fell
short, counterfeiters and other shady moneymakers were more than willing
to take up the slack, operating along a continuum that stretched from
rock-solid banks to bona fide frauds.
The contemporary observer who best captured the uneasy coexistence of
credit and fraud was not an economist but a novelist. In his book “The
Confidence Man,” Herman Melville offered a parable of the credit economy
and the paradoxical forces that sustained it. Set aboard a steamboat
drifting down the Mississippi River, the novel recounts the deceits and
deceptions of a shape-shifting impostor who preys on the credulity of
his fellow passengers, asking for their “confidence” in the form of
loans or other acts of trust. Yet even as he defrauds his victims, he
lectures them on the importance of extending credit. “Confidence is the
indispensable basis of all sorts of business transactions,” the
protagonist says. “Without it, commerce between man and man, as between
country and country, would, like a watch, run down and stop.” Melville’s
rogue was on to something: what was creditworthy and what was fraudulent
could easily turn out to be two sides of the same coin — or rather the
same bank note.
The collapse of the distinction between legitimate and fraudulent means
of making money can end badly. It certainly did in Niles’s and
Melville’s day. Not long after Niles predicted that the nation’s
overextended banks would come to grief, a calamitous panic drove many
lenders to break their paper promises; many of them went out of business
entirely. Yet a few years later, the credit system was alive and well,
and by the middle of the 1830s an era of wild land speculation was under
way, with many more banks — and countless counterfeiters — pumping money
into the economy. Things didn’t turn out well then either: the panic of
1837 wiped out hundreds of banks, sinking the country into a brutal
depression. Another speculative bubble 20 years later ended on a
similarly catastrophic note.
It was only during the Civil War that the relationship between the
monetary system and the credit system began to change. At that point,
the federal government entered the business of printing paper money,
issuing a forerunner to today’s greenback in order to pay for the war.
Federal legislation taxed the older system of bank notes out of
existence and left the government with the start of a monopoly over the
money supply. And so began a halting, decadeslong evolution toward the
money that we know and — at least for the moment — trust.
But credit-driven capitalism did not disappear. The spirit of financial
trickery assumed new incarnations in the succeeding century: the
stock-market manipulator, the pyramid-scheme promoter. With the
proliferation of no-doc mortgages, interest-only loans and a dizzying
array of new financial instruments, there is ample proof that America
remains in the broadest sense what Hezekiah Niles once described as “a
nation of counterfeiters.” Genuine counterfeiters no longer lurk in
every corner of the financial system, but a new crop of miscreants has
fueled the boom: fraudulent real-estate appraisers, for example, and
companies offering “credit repair” services that erase bad credit by
“borrowing” someone else’s more reputable history of paying his bills on
time. Some of these practices are illegal; others are within the bounds
of the law. The murky business of devising collateralized mortgage
obligations, whereby subprime mortgages can be born again as new,
lower-risk securities, is legal. Whether it is a good idea is another
thing altogether.
Perhaps the current wave of debt machinations will end badly. Then
again, in the long run, it may not. Consider the impressions of another
novelist, the British writer Frederick Marryat, who visited the United
States in the wake of the panic of 1837. As he surveyed the wreckage of
broken banks and worthless paper, he came to a surprising conclusion.
“If all the profits of the years of healthy credit were added up,” he
wrote, “and the balance sheet struck between that and the loss at the
explosion, the advantage gained by the credit system would still be
found to be great. The advancement of America depends wholly upon it. It
is by credit alone that she has made such rapid strides, and it is by
credit alone that she can continue to flourish.”
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