Lombard Street: A Description of the Money Market (1873) is an influential book by Walter Bagehot

Walter Bagehot

Walter Bagehot was an English businessman, essayist, and journalist who wrote extensively about literature, government, and economic affairs.-Early years:...

. Bagehot was one of the first writers to describe and explain the world of international and corporate finance

Finance

"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...

, banking, and money

Money

Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...

 in understandable language.

Overview

The book was in part a reaction to the financial collapse of Overend, Gurney and Company

Overend, Gurney and Company

Overend, Gurney & Company was a London wholesale discount bank, known as "the bankers' bank", which collapsed in 1866 owing about 11 million pounds, equivalent to £981 million at 2008 prices.-Early years:...

, a wholesale discount bank located at 65 Lombard Street, London

Lombard Street, London

Lombard Street is a street in the City of London.It runs from the corner of the Bank of England at its north-west end, where it meets a major junction including Poultry, King William Street, and Threadneedle Street, south-east to Gracechurch Street....

, from which the title draws its name. When this bank suspended payments on 10 May 1866, panic spread across London, Liverpool, Manchester, Norwich, Derby and Bristol.

Lender of last resort

Lombard Street is known for its analysis of the Bank of England

Bank of England

The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...

's response to the Overend-Gurney crisis. Bagehot's advice for the lender of last resort

Lender of last resort

A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to...

 during a credit crunch

Credit crunch

A credit crunch is a reduction in the general availability of loans or a sudden tightening of the conditions required to obtain a loan from the banks. A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates...

 is summarized by Charles Goodhart

Charles Goodhart

Charles Albert Eric Goodhart, CBE, FBA is an economist. He was a member of the Bank of England's Monetary Policy Committee from June 1997-May 2000 and a professor at the London School of Economics . He is the developer of Goodhart's law, an economic law named after him...

 as follows:

• Lend freely.
• At a high rate of interest.
• On good banking securities.

(Nonetheless, Goodhart emphasizes that many of these ideas were spelled out earlier by Henry Thornton's book The Paper Credit of Great Britain.)

In Bagehot's own words (Lombard Street, Chapter 7, paragraphs 57-58), lending by the central bank

Central bank

A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...

 in order to stop a banking panic should follow two rules:

First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.

Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them. The reason is plain. The object is to stay alarm, and nothing therefore should be done to cause alarm. But the way to cause alarm is to refuse some one who has good security to offer... No advances indeed need be made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimally small fraction of the whole business... The great majority, the majority to be protected, are the 'sound' people, the people who have good security to offer. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed. But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.

External links

• Lombard Street: A Description of the Money Market from Project Gutenberg
  Project Gutenberg
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• Text at Library of Economics and Liberty