The Precipitation and Fall of Mess. Douglas, Heron, and Company,

case-study in Adam Smith's Wealth of Nations

The first and only edition of this cautionary tale on the dangers of lending beyond your reserves, which formed the anonymous case-study at the centre of the second chapter in Book II of Adam Smith's Inquiry into the Nature and Causes of the Wealth of Nations.

20-years of strong economic growth had led to an over-supply of paper money in Scotland where, as Smith notes, there existed a peculiar tradition in banking of granting credit on easy terms. As a result, there was a general inadequacy in the cash basis of the nation, which led to government intervention, and the adoption by the chartered banks of a restrictive lending policy.

In this climate of tightened credit, 'a new bank was established in Scotland for the express purpose of relieving the [economic] distress of the country. The design was generous, but the execution imprudent' (Wealth of Nations, Book II, Chapter II). This was Mess. Douglas Heron and Co., better known as the Ayr Bank, a provincial enterprise with an impressive list of shareholders including the Duke of Queensbury and Dover, the Earl of Dumfries etc., drawn from the landed gentry. It was founded ostensibly with the public spirited objective of advancing capital on any reasonable security, and so funding improvements to land and industry that had grown to a halt as a result of the credit crunch.

Unfortunately, from the beginning the bank lacked proper fiscal foresight. It extended lines of credit well-beyond its own reserves, coming soon to represent two-thirds of the currency then circulating in Scotland, and was soon unable to meet its withdrawal obligations. It was then that the bank fell into the 'ruinous mode of raising money by a chain of bills on London' at great cost in both terms of interest and commission paid to its London agents (Sir William Forbes).

It all came to a head in June 1772 with the collapse of the London bank Neale, James, Fordyce and Down. Alexander Fordyce, the leading partner, had become deeply indebted (to the tune of £300,000 in trading losses) speculating on Easy India Company stock, and had resorted to using the bank's deposits to cover his losses. Its collapse 'set fire to the mine, which at once blew up the whole traffic of circulation [i.e. the practice of raising money through a chain of bills] that had been carrying on for a number of years' (Forbes).

Ten banks fell within a fortnight, and up in Ayr, the bank's creditors panicked, doubting that they could meet their liabilities which had ballooned to some £1,120,000 in less than 3-years of operation. Failure was inevitable, and hit hard the land-owning shareholders, many of whom became insolvent and were forced to sell their estates to cover the losses.

Smith received news of the collapse of Ayr Bank from his close friend David Hume. Although he himself had no concerns in the bank, several of his close friends were impacted, and, as he wrote to William Pultney MP in September 1772, 'my attention has been a good deal occupied about the most proper method of extricating them'.

Ultimately, Smith concluded, that despite the best intentions the 'operations of this bank seem to have produced effects quite opposite to those which were intended'. That in giving temporary relief to businesses which should have been allowed to fail, they delayed the inevitable, causing further debt to be racked up and fall more heavily upon the borrower and themselves as creditor. 'In the long-run, therefore, the operations of this bank increased the real distress of the country which it meant to relieve' (Wealth of Nations, ibid).

This report was the result of an inquiry commissioned following a meeting of the partners in July 1776. It gives a full history of the affair, going into great detail on the 'general nature of the management' of the bank, which was characterised by 'over-trading, and endeavouring to force a circulation of the Company's paper beyond the natural limits' (p.18), with further itemised chapters going into specific 'acts of mismanagement'.

First and only edition; 4to (27 x 21.5 cm); ownership inscription in pen to title, bookplate to front pastedown, loose MS notes and copy of the Contract of Copartnery of Douglas Heron & Co., a little toned; contemporary paper-covered boards, rebacked, calf corners restored, lettering-piece to spine, later endpapers; xiii, [1], 167, [1], 133, [1], 31, [1], 34pp.