Sunday, November 30, 2014

John H. Dunn & The Financial Crisis of 1837


 Also available at mises.ca

It would be a grave mistake to neglect the financial crisis behind the Upper Canadian Rebellion of 1837 [1]. In the first half of the 19th century, Upper Canada was an economically-backward British colony. British money funded the roads, canals and trade routes designed to bring more settlers into the territory. The Canada Company, for example, financed a road between Guelph and Goderich. For this they paid their workers, not in specie, but in lots of land along the road.[2]

Canals were the main source of transportation for merchants. In the 1820s Upper Canada was not a popular spot for trade routes. This situation grew worse when De Witt Clinton built the Erie Canal. Traders didn't need Montreal let alone the Great Lakes and the Upper Canadian interior. They could now go right through to New York City.

This “threat” – if indeed it was one – was met by W.H. Merritt with the construction of the Welland Canal. Only problem was lack of financial interest in such a canal. Unable to raise money from private investors, Merritt sought government assistance. In 1827 the Upper Canadian legislature, convinced of the value of the project, authorized £27,000 to be raised through public debentures. As historian M.L. Magill writes, this “opened the flood gates to applications for large loans for public works.”

In the 1820s and 30s, to save on interest charges, issues of public debentures were relatively short-term. This had been going on for years with few problems. Then the situation started to change. As the legislature kept authorizing more and more issues for new public works projects, the public debt increased. By 1830 many debentures were approaching maturity and the province did not have the money to redeem them. This was the situation John H. Dunn, the Upper Canadian Receiver-General, found himself in.



Dunn became convinced that the solution was to raise a long-term loan outside the province large enough to redeem the public debt with enough left over to fund public works. This was nothing unorthodox, as the Province routinely looked to England for sources of money. However, this time that familiar route had been unsuccessful. So instead of trying to raise money through the British government, Dunn looked to the “American Houses” in London.

The “American Houses” were firms of private bankers in London who financed British trade with the United States. Although they originally started out as bankers for imports and exports, they had begun to float loans for some of the American States and municipalities. The American Houses often dealt in large amounts, made the money immediately available and should the first loan prove successful, were willing to finance more. Approaching these Houses was Dunn's solution to Upper Canada's money problems.

In 1830 the Upper Canada legislature passed two acts authorizing £90,000 to pay off claims and to redeem part of the public debt. The acts permitted the money to be raised in England but did not stipulate that it must be through the British government. This was the loophole Dunn needed. He sent his request to about a dozen firms offering them the deal, stating that £72,000 was immediately required. He received only two replies – from Barings Brothers & Co and from Reid Irving & Co. Both Houses declined on the grounds that the rate of interest was too low.

In 1833 the Upper Canadian legislature passed an act to authorizing £232,625 to pay off claims, improve roads and bridges, and redeem debentures reaching maturity. Dunn again tried to raise the money locally but received offers for only £10,110 in currency. Market demand for provincial debentures were virtually nil. Dunn once again wrote to the American Houses. Again, he received a reply from Baring Brothers & Co. who expressed interest in “relations with your flourishing province” but declined to do business based on the interest rate of the loan. It simply was not attractive to their customers nor did they personally regard the investment as suitable. Another response, however, was more encouraging. Thomas Wilson & Co expressed interest and made a tentative offer of £200,000 sterling at 5%, the money to be received in London and principal and interest to be paid there.

Dunn decided to go to London himself to negotiate with Thomas Wilson & Co. and to carry out the suggestion made by the Baring Brothers House.. Although the Baring Brothers had declined to finance the province, they suggested that someone from Upper Canada be sent to London to familiarize financial men with local conditions. This is what the Americans would do to generate interest.

Dunn was in London from September 5th to October 9th 1833 and had found no one prepared to offer better terms than Thomas Wilson & Co. He accepted their proposal. The loan was to be for twenty years, with principal and interest to be paid at their office and an additional 1% commission charge for their services. The proceeds of the loan were credited to the account of the province when the debentures were received. The arrangement was to be ratified within four months. Failure to do so would mean a withdraw of the offer.

Unlike previous arrangements between the Upper Canadian government and its financial agent, Dunn in effect sold the debentures directly to a firm of bankers as opposed to having a financial agent hold the debentures in trust for the government. By selling the debentures directly, the transaction was arranged so that, in the event of that Thomas Wilson & Co face bankruptcy while still in position of the debentures, they would form part of the assets available to creditors. The Province of Upper Canada would be in the same position as any other depositor and merely a creditor in the bankruptcy.

Although the agreement demanded ratification within four months, the Upper Canadian legislature was not in session when Dunn returned to British North America. The agreement was not ratified until March 6th 1834 although a resolution to accept the terms was passed in January. Dunn put on a bold face and sent the debentures with a simple note stating, “I shall presume that your disposition to aid the province still exists.” However, time didn't seem to be a deciding factor and on April 21st Dunn reported good news to the Executive Council.

Upper Canada now had the capital it needed. There was a demand for bills in London and particularly for bills drawn by a government on a well-known London firm. The scheme worked. Having secured a source of money, the province decided to ask for more. In April 1835, the legislature authorized Dunn to borrow £400,000. Dunn once again wrote letters the various Houses, including Thomas Wilson & Co. and Baring Brothers & Co., and set out to England without waiting for a reply.

Within days of his arrival he had offers for the whole sum from both the Baring Brothers and Thomas Wilson Houses. However, these offers did not arise from any actual productive value of Upper Canada. The Anglo-American trade during this time was in a credit bubble and buying these debentures would eventually turn out to be a malinvestment. The fact that Upper Canada was in North America was all that was required to make this speculative investment profitable. More prudent investors were aware of the growing tensions in Lower and Upper Canada. Dunn, a member of the Family Compact, assured British investors that these rumours were unfounded. Of course, Dunn's motivations were obvious: he was a director and sometimes president of the Welland Canal Company. He also held a high position at the Bank of Upper Canada.

Dunn made the deals with Thomas Wilson & Co and with the Baring Brothers & Co. The arrangement was exactly as it was before: the debentures were sold outright and the money received for them was left on deposits with the firms.

Dunn must have returned to Upper Canada satisfied that this scheme would work out for years. But while the boom continued its unsustainable path, Dunn found himself in hot water with his peers. Despite being a member of the Family Compact oligarchy, Dunn was also a Reformer and was convinced by Robert Baldwin to resign from Executive Council when Lt. Governor Bond-Head refused to consult with them on administrative appointments. Head was furious that Dunn supported the notion of “responsible government” and wouldn't forget this treasonous act.

Late in 1836, the market boom started to run out of steam. English manufacturers who depended on export to America found themselves in trouble. They cut down on imports and pressed their American debtors. This put pressure on the American banks who had not only overextended their credit but were caught up in the conflict between President Andrew Jackson and the Bank of the United States. The “American Houses” involved with financing the Anglo-American trade were the first to feel the pinch. By December many of these firms were in serious trouble and looked to the Bank of England for bailouts. Thomas Wilson & Co. were one of these banks. The Bank of England granted a short term loan but it only starved off collapse for a few more months.

The Province of Upper Canada was in trouble. They had over £170,000 sterling on deposit with Thomas Wilson & Co and the Baring Brothers & Co. Although Baring Brothers were fine, rumour in Upper Canada was that both houses had closed their doors. All the province had to show for the sterling was a claim in the bankruptcies. This money represented debentures which had been sold to the public. Not only would these have to be redeemed, but the meantime interest would have to be paid. The bust threatened the entire economy of Upper Canada. Interest would have to be paid out of public revenue. Default was in order. The collapse of the currency was inevitable.

The banks of Upper Canada had very little capital. Although specie was legal tender, everyone used notes issued by the banks. The inability of the banks to redeem these notes with specie was an obvious problem. The Province was flooded with useless paper, yet the authorities did what they could to dispel rumors. Lt. Governor Bond-Head knew enlisting the help of England through the Colonial Office was necessary. However, due to Head's personal vendetta against Dunn for his Reformist tendencies, Head decided to send W.H. Draper to England as his confidential agent. Dunn, nevertheless, decided to go to England on his own accord.

As Receiver-General, Dunn was personally liable for the public revenue. As he sailed across the ocean, dozen of firms in both England and the United States were failing. On June 3rd 1837, Thomas Wilson & Co. closed its doors. Although insolvent, the House had sufficient assets to pay their creditors, but due to the collapse of the boom, they were unable to convert their assets into cash. Majors problems surfaced because Thomas Wilson & Co. had acted as agents for many Canadian banks: The Bank of Montreal, The City Bank, The Bank of Upper Canada, and the Commercial Bank of the Midland District. They had been financing Canadian trade with England by selling bills drawn against their deposits. With Thomas Wilson & Co. going under, these bills would have to be dishonored. Arrangements were made to transfer the bank agencies to sounder firms – The Bank of Montreal to Smith Payne & Co, the City Bank to the Bank of British North America, the Commercial Bank of the Midland District to the London Joint Stock Bank and the Bank of Upper Canada to Glyn Mills & Co.

At the Colonial Office Lord Glenelg was furious to hear that Lt. Governor Bond-Head had sent Draper instead of Dunn. He was also furious that the province had been raising loans without the advice or knowledge of His Majesty's Government. This was a major embarrassment for the Colonial Office and Lord Glenelg was eager to sweep it under the rug. Lord Glenelg feared the “writ of extent” in which the Crown would seize all the assets of its debtor and sell them to recover its claim without regard to the rights or claims of the other creditors. If this writ were issued, the creditors of Thomas Wilson & Co. would recover nothing. Fortunately issuing a writ was not politically attractive for either Glenelg or the government in the House.

At this point it's necessary to take a step back and consider the mess Upper Canada found itself in. In essence, John H. Dunn had, without the knowledge of the government, borrowed large sums of money from private bankers and then lost a large portion of it in an economic bust that inflicted the entire Anglo-American world. In order to remedy the situation the British government would had to issue an extent that would ruin the credit rating of Upper Canada for years to come.

The immediate problem was that the debentures sold through Thomas Wilson & Co. were due in July along with the interest. If not paid by then, the British colony would default on its public obligations. When Baring Brothers & Co. wrote to Dunn, they offered to be responsible for what was due through Thomas Wilson & Co. But this was only for six months. What was needed was an official financial agent for the province, which would be willing and able (using its own resources) to meet the obligations of the province and secure future revenue. On June 10 1837, Glyn Mills & Co. became the official agent for the Bank of Upper Canada. Both Glyn Mills & Co. and Baring Bros. & Co worked together in the province, despite the former being the only official agent.

While these deals were made, Dunn and Draper were still on the ocean. Dunn arrived first. Although he heard some “pointed remarks” from the Colonial Office, he was put in touch with Glyn Mills & Co. and left to work out the arrangements. Although submitting to Glyn Mills & Co. demands made him unpopular in Upper Canada (many public works went unfinished as the province handed over its claim on Thomas Wilson & Co.) he had little choice but to accept the help offered to him by powerful British bankers.

Draper arrived a few days later. He was subsequently ignored by the Colonial Office until he finally got to see Lord Glenelg for a few minutes. Draper suggested the Crown issue an extent of writ. The very thing the Colonial Office sought to avoid. No one was impressed with Head's decision to send Draper. Glenelg wrote to Head explaining why an extent was unfavourable. While this happened, Dunn closed the deal with Glyn Mills & Co. Impressed, Glenelg had nothing but praise for Dunn and this may have contributed to Dunn's life-time position as Receiver-General of Upper Canada.

John H. Dunn returned to Upper Canada having to deal with the subsequent depression of 1837 and the Rebellion led by William Lyon Mackenzie. The Rebellion, no doubt, partly caused by the additional £600,000 debt and £30,000 a year in interest payments to British bankers. Not to mention the half-finished canals littering the province.

Interestingly, the introduction of Glyn Mills & Co. and Baring Brothers & Co. into the financial affairs of the British North American colonies would eventually lead to Confederation. But that's another story that has been told elsewhere.


Sources:

[1] For a longer version of this story, see:
Magill, M.L. "John H. Dunn and the Bankers." Historical Essays on Upper Canada New Perspectives. Ottawa, Canada: Carleton UP, 1991. 194-215. Print.

[2] Karr, Clarence G. "The Two Sides of John Galt." Historical Essays on Upper Canada New Perspectives. Ottawa, Canada: Carleton UP, 1991. 194-215. Print.

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