Bagehot's Giant Bubble Failure

40 Pages Posted: 6 Sep 2019 Last revised: 30 Sep 2023

See all articles by Andrew Odlyzko

Andrew Odlyzko

University of Minnesota - Twin Cities - School of Mathematics and Digital Technology Center

Date Written: August 30, 2019


Walter Bagehot is remembered today primarily for his advocacy of the
doctrine of lender of last resort, in which central banks pump money
into the economy to ameliorate the damage from a financial crisis.
There is a lack of information in the literature about the extent to
which, as the editor of the "Economist," he warned his readers about
the bubble that collapsed in the famous Overend crash of 1866 and
which has striking similarities to the one that led to the Global
Financial Crisis of 2007-2008. This paper shows that, unlike most
modern finance experts, Bagehot was convinced that bubbles exist,
and that some can be identified beforehand. However, while he was
alarmed by some of the anomalies observed in the British market of
the 1860s, he overlooked some important statistics, and did not
succeed in penetrating the depths of "financial engineering" that
concealed the ugly reality that led to the crisis. He convinced
himself that Britain had entered a new economic era, and that new
rules applied, and it took the crash to disabuse him of that notion.
Since hardly any of the other prominent observers of the time did
much better, this may not have been a giant failure, but it was a
failure to identify a giant bubble. The British investment mania
that led to the crisis of 1866 is of substantial relevance, as it
was probably the first large case where "financial innovation" came
to play a large role in leading investors and disinterested but
curious and knowledgeable observers astray. It suggests we should
not expect regulators to be able to detect bubbles in the future

Keywords: Bagehot, bubbles, panic of 1866

JEL Classification: E44, G10, G24, L92, N23, N73, O16, O33, O38, R42

Suggested Citation

Odlyzko, Andrew, Bagehot's Giant Bubble Failure (August 30, 2019). Available at SSRN: or

Andrew Odlyzko (Contact Author)

University of Minnesota - Twin Cities - School of Mathematics and Digital Technology Center ( email )

127 Vincent Hall
206 Church St. SE
Minneapolis, MN 55455
United States
612-625-6413 (Phone)
612-626-2017 (Fax)


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