The Panic of 1825 Included Bonds From a Country That Did Not Exist
A London lending boom into newly independent Latin American states ended in a banking crisis. One of the sovereign borrowers had been invented by the man selling its debt.
The Lending Boom
In the early 1820s, Spanish colonies across South America achieved independence. The new republics needed money and turned to London, then the centre of global finance.
British investors, facing low yields on domestic government debt after the Napoleonic Wars, were receptive. Loans were issued for Colombia, Peru, Chile, Mexico, and others, at yields well above British consols.
Speculation extended to mining companies formed to exploit South American deposits, many of which existed more in prospectus than in operation.
Low yields on safe domestic assets push investors toward unfamiliar borrowers offering more. That mechanism is two centuries old and has not changed.
Poyais
The most remarkable episode involved a country that did not exist.
Gregor MacGregor, a Scottish soldier who had served in South America, promoted a territory called Poyais on the coast of Central America, presenting himself as its ruler. He described a developed settlement with fertile land, infrastructure, and a functioning government.
He issued bonds in London, which traded alongside genuine sovereign debt. He also sold land and encouraged emigration.
Settlers who travelled there found uncleared jungle. Many died. The survivors who returned made the fraud public.
What makes the episode instructive is not that a fraud occurred but that the securities traded in a functioning market alongside real ones. Investors had no practical means of verifying claims about distant territories, and the prospectus was the only information available.
The Crisis
By late 1825 several of the new republics were in difficulty. Defaults began, and the mining ventures largely failed to produce anything.
The Bank of England had been expanding credit and then tightened as its gold reserves fell. Country banks, which issued their own notes and were often thinly capitalised, came under pressure.
| Stage | Event |
|---|---|
| Boom | Lending to new states, mining speculation |
| Deterioration | Defaults, mining ventures fail |
| Tightening | Bank of England restricts credit |
| Panic | Large scale country bank failures |
| Response | Bank lends extensively, panic subsides |
A substantial number of banks failed. The Bank of England eventually lent on a large scale, and one director later described the intervention as having been made by every possible means and in modes never adopted before.
What It Established
The episode is generally treated as the first modern emerging market debt cycle, containing every element that recurs.
Low returns at home push capital toward unfamiliar higher yielding borrowers. Information about those borrowers is poor, and the intermediaries selling the securities are the main source of it. Enthusiasm compresses the yield premium below what the risk justifies. A tightening of conditions in the lending centre, rather than any change in the borrowers, triggers the reversal.
Latin American borrowing cycles subsequently repeated in the 1870s, the 1920s, the 1970s, and the 1990s, following recognisably similar patterns.
The Regulatory Consequence
The crisis prompted reform of British banking, including allowing joint stock banks outside London, which were better capitalised than the small partnership banks that had failed.
It also strengthened the argument that the Bank of England had a responsibility to the wider system rather than only to its own shareholders, which was the debate Bagehot later resolved.
The Bottom Line
The Panic of 1825 followed a London lending boom into newly independent South American states, complete with mining ventures that produced nothing and bonds issued for a country that was invented. Its structure, yield chasing into poorly understood borrowers reversed by tightening at home, is the template every subsequent emerging market debt cycle has followed.