This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: The Development of Central Banking Practice in the Mid-Nineteenth Century: Robert Peel’s Successors and “Suspension Letters”

But that the 1844 Bank of England Recharter Act made lender-of-last-resort operations illegal did not mean that they were not thereafter undertaken.

As Robert Peel wrote in 1844, looking back on the Bank Recharter Act, the mere fact that the Act had made lender-of-last-resort operations illegal did not mean that they should not or would not be undertaken:

My confidence is unshaken that we have taken all the Precautions which legislation can prudently take up against the Recurrence of a pecuniary Crisis. It my occur in spite of our Precautions, and if it does, and if it be necessary to assume a grave responsibility for the purpose of meeting it, I dare say men will be found willing to assume such a responsibility. I would rather trust to this than impair the efficiency and probable success of those measures by which one hopes to control evil tendencies in their beginning, and to diminish the risk that extraordinary measures may be necessary...

Peel saw a choice: either (i) give the Bank of England explicit powers (and so run the risk that financiers, expecting that those powers would be used, would exploit moral hazard and so produce irrational exuberance, extravagant overleverage, and repeated frequent financial crises), or (ii) forbid the Bank of England from acting and rely on financial statesmen in the future to take actions ultra vires under the principle that in the end salus populi suprema lex. Peel chose (ii). To him and his peers, the risks that granting explicit powers would enable moral hazard appeared greater than the risks that when a crisis should come the makers of monetary policy would not understand that their proper role was to create enough “outside money” to satisfy the panic demand for safe, liquid assets and so eliminate the gap between planned economy-wide spending and expected income that would otherwise generate a deep economic downturn.

And, indeed, Peel’s expectations of how his successors would act in a crisis were rational. Men were indeed found willing to assume a grave responsibility and go ultra vires and undertake actions that they had no legal power to perform—indeed, actions that they were expressly forbidden by the terms of the Bank of England’s new charter from undertaking. The Governors of the Bank of England, however, would not expand their balance sheet beyond its legal limit purely on their own initiative, however. They required first a blessing from the government of the day.

The blessing took the form of a “suspension letter” written by the Chancellor of the Exchequer—the British Treasury Secretary. First in 1847 and then in 1857 and then in 1866, the Chancellor would write a letter to the Governor of the Bank of England stating that he was suspending for the duration of the financial crisis those provisions of the 1844 Bank Recharter Act of 1844 that restricted the Bank of England’s ability to expand its balance sheet. Nothing in the black-letter law or in previous custom gave the Chancellor any such power to at his will suspend provisions of a corporation charter and grant the corporation extra privileges and powers above those Parliament had granted it. Successive Chancellors did so anyway. They judged it, as Peel had foretold: “necessary to assume a grave responsibility for the purpose of meeting” the crisis. They did so. And few people complained.

One who did complain was the irate Karl Marx. He asked whether:

it [will] be believed that the Committee has contrived to simultaneously vindicate the perpetuity of the law and the periodical recurrence of its infraction? Laws have usually been designed to circumscribe the discretionary power of Government. Here, on the contrary, the law seems only continued in order to continue to the Executive the discretionary power of overruling it. The Government letter, authorizing the Bank of England to meet the demands for discount and advances upon approved securities beyond the limits of the circulation prescribed by the Act of 1844, was issued on Nov. 12...

The reason that few people complained was that the system seemed to work less badly than other systems that could be envisioned. The system was inconsistent—and that annoyed Marx. But the Act’s originator’s blessing of ultra vires lender-of-last-resort powers coupled with the Act’s text’s forbidding of them accomplished Charles Kindleberger’s “neat trick... sleight of hand... trick with mirrors...” and made it possible for the “lender of last resort... [to] exist... but [for] his presence [ex ante] tp be doubted”; for the Bank of England to “come to the rescue in order to prevent needless deflation, but always leave it uncertain whether rescue will arrive in time or at all, so as to instill caution...”

And most frequently, in the third quarter of the nineteenth century at least, the taking on of risk onto the Bank of England’s books and the issuing of additional banknotes above the legal limit was not needed: simply the declaration that the Chancellor of the Exchequer had sent a suspension letter to the Governor of the Bank of England, or even was just planning to send a suspension letter, was enough to eliminate the high demand for additional safe, liquid savings vehicles all by itself.