Buy the Book: The authors tell the story of the Panic of 1907 and how fragile complex systems can be. The authors recount the events that led up to the panic, the actors that pushed it to the brink, the efforts taken to halt it, and the aftermath that led to the creation of the Federal Reserve.
The Notes
- There were 13 bank panics in the U.S. from 1814 to 1914. The Panic of 1907 was one of the worst.
- The Cycle of Bank Panics:
- Speculation in land and/or securities led to bubble prices that correct when expectations fall short of reality.
- As asset prices adjust lower, banks called in loans with pledged collateral falling in price.
- Borrowers, unable to repay those loans, defaulted.
- Bank depositors grow nervous about the survival of the bank and withdraw their funds.
- One bank failure leads to a run on the banks.
- Since the U.S. had no central bank in 1907 to supply liquidity, it was up to the biggest banks and bankers to be the lender of last resort.
- Elements of a Perfect Storm:
- “System-like architecture. Complexity makes it difficult to know what is going on and establishes linkages that enable contagion of the crisis to spread.
- Buoyant growth. Economic expansion creates rising demands for capital and liquidity and the excessive mistakes that eventually must be corrected.
- Inadequate safety buffers. In the late stages of an economic expansion, borrowers and creditors overreach in their use of debt, lowering the margin of safety in the financial system.
- Adverse leadership. Prominent people in the public and private spheres implement policies that raise uncertainty, which impairs confidence and elevates risk.
- Real economic shock. Unexpected events hit the economy and financial system, causing a sudden reversal in the outlook of investors and depositors.
- Undue fear, greed, and other behavioral aberrations. Beyond a change in the rational economic outlook is a shift from optimism to pessimism that creates a self-reinforcing downward spiral. The more bad news, the more behavior that generates bad news.
- Failure of collective action. The best-intended responses by people on the scene prove inadequate to the challenge of the crisis.”
- U.S. Economy: mid-1890s to 1906
- 7.3% annual growth rate.
- Gold imports peaked.
- Mergers were the major trend. Over 1,800 companies were consolidated into 93 corporations. It resulted in oligopolies and monopolies.
- A major bull market was thriving in 1905.
- Banking System in 1907:
- No central bank existed at the time.
- National Banks — could get federal deposits and issue government-licensed currency.
- State Banks — chartered by state legislation.
- Private Banks — like J.P. Morgan & Company to smaller private banks.
- Trust Companies — a type of bank for the wealthy, offered higher rates, was less regulated, had lower reserve requirements than banks, and was allowed to hold a wider variety of assets like stocks. Over a thousand trust companies existed in 1906. The trust companies in NYC held a similar amount of assets as all national banks.
- Knickerbocker Trust Company — Founded in 1884 by Fred Eldridge and grew to be one of the largest trusts in the country by 1907.
- “Regulations…required rural banks to hold reserves equal to 15 percent of their deposits; 40 percent of these reserves had to be held in cash, but the balance could be placed on deposit at “reserve city” banks, where the reserves could earn interest. These reserve city banks had to hold 25 percent of their deposits in reserve and half of those reserves in cash; these banks, in turn, could place their noncash reserves on deposit with banks at major money centers, such as New York. However, many of the banks in New York and other major financial cities were heavily involved in the securities markets, particularly in railroad underwritings. Therefore, instability in securities prices could potentially prompt anxiety among depositors. If that anxiety precipitated a “run on the bank,” an abrupt systemwide contraction could result.”
- “The deficiencies of this system were manifest. First, many contemporary critics charged that the currency of the United States was “inelastic,” meaning that the volume outstanding could not adjust easily to meet variations in economic cycles, bumper crops, or shocks. Second, no single regulatory agency monitored monetary conditions or the overall stability of the financial system as a basis for promoting disciplined lending. Third, the mechanism by which banks paid cash against checks (called “clearing”) was accomplished only through voluntary associations among banks in certain cities called “clearing houses.””
- Clearing Houses — allows several banks to the risk of any one member not being able to cover checks by issuing “clearing house certificates.” The certificates helped add liquidity to the system. There was no consistent rules or regulation on how clearing houses should be run.
- “During previous financial crises, such as in 1873, 1884, 1890, and 1893, the New York Clearing House (NYCH) had resorted to issuing temporary, emergency loans to its member banks in the form of clearing house certificates. The banks had substituted these certificates for currency when clearing accounts with one another at the clearing house each day. Since the certificates circulated among member banks as a substitute for cash, they effectively freed up actual cash for the public, thereby artificially expanding the nation’s money supply. Without a central bank to provide this function, the certificates proved to be extremely effective at restoring liquidity to the financial system during critical periods of stringency.”
- J. Pierpont Morgan
- THE informal leader of finance in the U.S.
- “Morgan seemed to feel that the business machinery of America should be honestly and decently managed by a few of the best people, people like his friends and associates. He liked combination, order, the efficiency of big business units; and he liked them to operate in a large, bold, forward-looking way. He disapproved of the speculative gangs who plunged in and out of the market, heedless of the properties they were toying with, as did the Standard Oil crowd. When he put his resources behind a company, he expected to stay with it; this, he felt, was how a gentleman behaved. His integrity was solid as a rock, and he said, “A man I do not trust could not get money from me on all the bonds in Christendom.” That Morgan was a mighty force for decent finance is unquestionable. But so also is the fact that he was a mighty force working toward the concentration into a few hands of authority over more and more of American business.” — Frederick Lewis Allen
- Helped President Grover Cleveland raise gold to fix the liquidity crisis in 1893.
- Stepped in to consolidate and reorganize failed companies (mostly railroads) and pushed a more prudent management style.
- He disliked “ruinous competition.” He pushed for merging companies into massive monopolies or duopolies to drive out competition.
- “There was nothing he disliked more than unrestricted competition and aggressive expansionism, which he considered wasteful and destructive. Morgan believed in orderly industrial progress, and he endorsed policies aimed at promoting cooperation. Large enterprises, he affirmed, should adhere to the principle of community of interest, not the Spencerian doctrine of survival of the fittest.” — Vincent Carusso
- Responsible for mergers that formed AT&T, International Harvester, American Tobacco, Nabisco (National Biscuit), U.S. Steel, and more.
- San Francisco Earthquake
- The earthquake struck San Fran on April 18, 1906.
- Broken mains engulfed the city in flames.
- Over half the city was leveled — over 4 square miles. Damages were estimated between 1.2% to 1.7% of U.S. GNP at the time or $350 to $500 million.
- NYSE dropped about 12.5% on the news. Railroad and insurance companies fell 15% to 30% over the following two weeks.
- Most people were insured against fire, not earthquakes. British insurance companies were hit hardest, covering half the city’s fire policies. Some insurers were forced to liquidate holdings to pay claims. Forced selling pushed market prices lower.
- It also increased gold imports from Britain to the U.S. Liquidity fears in Britain pushed the Bank of England to raise rates from 3.5% to 6%.
- The U.S. hit a severe credit shortage by the winter of 1906-7.
- President Teddy Roosevelt
- Pushed a policy of antitrust laws and regulation to combat the trend in corporate mergers in the U.S.
- “By 1907, Americans had become increasingly disturbed by the tumultuous changes that had accompanied the country’s impressive industrial growth. They were worried about the number and type of immigrants entering the country; the size, noise, and frenzy of the nation’s large cities; the effectiveness of their elected representatives; the consequences of old age, illness, and injury on the job; the day-to-day hazards of urban life; and even the quality of their food and water. Yet most of all they reacted with alarm to the rise of big business and the corporate merger movement. Some Americans, calling themselves “progressives,” argued vociferously for the right of a community to protect itself against those who pursued their economic self-interest without concern for the common good. President Theodore Roosevelt became their most outspoken proponent.”
- “I believe in corporations… They are indispensable instruments of our modern civilization; but I believe that they should be so supervised and so regulated that they shall act for the interest of the community as a whole.” — Teddy Roosevelt
- His administration sued over 40 companies under the Sherman Antitrust Act by 1907.
- Charles W. Morse
- Controlled the National Bank of North America, New Amsterdam National Bank, and a large number of shares in Mercantile National.
- Morse’s strategy was known as chain banking. Buy controlling interest in a bank, use that bank’s equity as collateral to borrow money to buy an interest in another bank, then repeat the process. It worked great for building wealth until a banking crisis set off a domino effect. If one bank failed, it led to another and another, until each bank in the chain failed.
- He was viewed as unsavory in banking circles.
- He was convicted of misappropriating bank funds and sentenced to 15 years in prison. His sentence was commuted by President Taft in 1912 due to an “illness” that was later revealed to be caused by him eating soap.
- He formed a new steamship company in 1912 and used it to bid on ship contracts during WWI, where he was later indicted and acquitted of fraud and war profiteering.
- Charles T. Barney
- President of the Knickerbocker Trust Company.
- Had ties to Charles Morse and the financial institutions he controlled. He was a director in several of Morse’s banks and on the board or major shareholder of several companies Morse controlled. The Knickerbocker also held positions in several of Morse’s businesses.
- He died of an apparent suicide on November 14, 1907.
- Fritz Augustus Heinze
- Moved to Butte, Montana to make a fortune mining cooper in 1889.
- Created a smelting operation for smaller mines and pioneered new methods to smelt copper — Montana Ore Purchasing Company in 1891.
- He bought mines next to the richest copper mines in Montana. If the veins of copper in the rich mines surfaced on his mines, he threatened litigation. Montana’s apex law, allowed mine owners to follow any vein that surfaced — “apexed” — on their property even if reached into the neighboring property. The mine owner could legally stop the neighbor from mining the vein. Heinze had 37 lawyers working for him, filing lawsuits against other mining companies, with a peak of 133 lawsuits pending at one point.
- Heinze’s biggest opponent in these lawsuits was John D. Rockefeller and Amalgamated Copper, which was formed in 1898. Amalgamated bought properties next to Heinze’s mines which he was litigating. Heinze refused to join the Amalgamated combination, counterclaims were issues, and the legal issues dragged on for years.
- Amalgamated Cooper bought out most of Heinze’s mines for $12 million in February 1906. Heinze took his $12 million to Wall Street.
- Heinze used his buyout windfall to buy the Mercantile National Bank in New York and named himself president in February 1907. Heinze joined Morse as a director in a chain of 6 national banks, 10 or more state banks, five trust companies, and four insurance companies.
- Heize consolidated the rest of his properties in Nevada, California, Mexico, etc. into a holding company called United Copper Company. He made his two brothers — Otto and Arthur, and himself major shareholders.
- United Copper shares were used as collateral to buy an interest in banks, trusts, and insurance companies.
- He bought a seat on the NYSE for $96,000 and created the brokerage named Otto C. Heinze & Company.
- Through the brokerage, and help from Morse, they created a stock pool to support United Copper shares. They also borrowed $2 million from other brokers to buy additional shares to prop up the stock price.
- He also owned a small bank called the State Savings Bank of Butte, Montana. It was the largest bank in Montana. It held funds from the National Mercantile Bank, $1 million in loans to Heinze interests, and United Copper shares as collateral on other loans.
- He was ruined in the panic and died in 1914.
- Timeline
- The stock market peaked in September 1906, then fell 7.7% by the end of February 1907. The start of a “silent crash.”
- The market dropped 9.8% in March 1907. Shipping, mining, steel, iron, and street cars were hit hardest — all down 13% to 17%.
- March 14: “The whole situation is most mysterious; undoubtedly many men who were very rich have become much poorer, but as there seems to be no one breaking, perhaps we shall get off with the fright only.” — Jack Morgan
- March 23: “Lack of confidence is never reflected more unerringly than in the money market; and the seriousness of the situation in that regard is shown in the inability of the railroads for over a year past to finance their new capital needs.” — Commercial and Financial Chronicle
- Market selling paused the last week of March. Needed liquidity was filled by gold bought in London and shipped to the U.S. and U.S. Treasury deposited $15 million in New York banks. Things were almost optimistic.
- April 13: “The monetary situation has reversed its character for call money, from abnormally high to abnormally low rates—the relief in New York communicating a like tendency elsewhere. This change has opened the stock market here to more venturesome buying, and consequently speculative operators have again been in evidence.” — Commercial and Financial Chronicle
- The market saw a slow decline of 3% during April and May.
- April 1907: The value of bankruptcy claims jumped 38% year over year.
- June 1907: “All the world is still in the dumps here, and with it we have everything else that comes with the Summer-time, and transactions on the Stock Exchange become smaller and more nominal daily. A rest is just what is needed, however, and I think that the next change ought to be an improvement of business, since it could not be worse. But when the next change will come I cannot as yet see—nor what will start it.” — Jack Morgan
- Summer 1907: Bank of England prohibited U.S. finance bills — loans U.S. firms used to import gold. Gold imports to the U.S. stopped and reversed course. It created another liquidity issue.
- June 28: New York City failed to float a $29 million bond offering. The 4% tax-exempt interest rate allowed by law on NYC bonds was far below the 6% to 7% rate on the railroad and corporate bonds in the market.
- July 19: “The money situation is now controlling everything, and there is not enough money around in this country, or in England, or on the Continent, at the moment, to finance a stock-market speculation if it arrived. As against this, people are saving money all the time and are making few new commitments, and also there seems to be a decrease in the money-hunger of the railroads, so that with care and conservatism we ought to be able to get through the Autumn stringency without any more panic.” — Jack Morgan
- The stock market dropped 8.1% from June through September 1907 — year to date decline of 24.4% through Q3 1907.
- August 1: U.S. Steel reports a 25% year-over-year decline in the book business.
- August 3: Standard Oil Company was fined $29.24 million for violating laws against secret rebates from railroads.
- Late August 1907: New York City tries to float a $40 million tax-exempt bond offering at 4.5%. The city was running out of money. The city approached J. Pierpont Morgan for assistance. It bond issue was a success.
- October 1907: “The New York money market entered the fall of 1907 low on gold reserves and vulnerable to shocks that might otherwise have been temporary in nature.” — Odell and Weidenmier, economists
- United Copper Short Squeeze Scheme
- October 9, 1907: Otto Heinze believed that people were attempting to short United Copper due to an excessive number of shares being traded in the market compared to actual shares in existence (25,000 more shares traded than existed). Otto believed he and his brothers owned the majority of the United Copper shares.
- The Scheme: Buy up the remaining United Copper shares, call in all shares loaned to short sellers, and create a short squeeze.
- October 10: Otto proposes the idea to Augustus to borrow $1.5 million from National Mercantile Bank to buy remaining shares. Augustus denies the requests. Mercantile has experienced a silent run on the bank, losing $4 million in deposits. Otto approached Morse, and Barney, who suggest the scheme would require more money than he expects and also denied his request.
- October 12: Shares in United Copper open at $45 1/2 and drop to $37 3/4.
- October 13 (Sunday): Otto goes ahead with his scheme alone. He puts an order in at the broker Gross & Kleeberg to buy 6,000 shares of United Copper.
- October 14: United Copper opens at $39 7/8, Otto’s bids hit the curb, and the price soars to $62 1/2 before closing at $52 7/8. Having bought United Copper shares, Otto forces his brother Augustus’s hand. National Mercantile supplies a loan to cover the cost of the shares.
- October 15: Otto calls in all Heinze-owned shares loaned to short sellers across 20 brokers. United Copper opens at $50, rises to $59, then breaks — down to $36. Every Heinze share was returned without incident. No defaults. Otto was wrong!
- October 16: United Copper opens at $30, dropped to $20 within 3 minutes. It fell to $10 in the last hour of trading. United Copper’s common was down $50 in three days. Its preferred was down $50 in two days.
- October 16: Gross & Kleeberg suspend all trading that afternoon. It was the most active buyer in United Copper thanks to Otto. The Hienze’s refused to pay for the shares now selling at $10.
- October 17: The NYSE suspends Otto Heinze & Company for failure to pay financial obligations. Augustus Heinze resigns from the National Mercantile under pressure from the bank’s directors. National Mercantile’s gross deposits fell 42% from $20 million in April 1907 to $11.5 million on October 12.
- October 18: State Savings Bank of Butte, Montana announces its insolvency.
- October 17: The “silent run” on the National Mercantile is no longer quiet. The New York Clearing House (NYCH) announces it stands by the National Mercantile Bank, claims it’s solvent, and would open as usual the next day.
- October 18: Run on the National Mercantile grows. Its cash reserves decline fast.
- October 19: The run on National Mercantile continues. The NYCH learns that the Mercantile held a large amount in loans to the Hienzes.
- October 19: Depositor worry spreads to banks controlled by Charles Morse due to his association with the Hienzes. The NYCH inspects the National Bank of North America and New Amsterdam National.
- October 20: The NYCH removes Augustus Heinze and Charles Morse from all banking interests in New York City and forces them to repay all outstanding loans to those banks. The NYCH also threatened to disqualify any bank from receiving aid if it was involved in chain banking. The National Mercantile would be liquidated. Augustus Heinze was ruined.
- October 21: “The action of the Clearing House on Saturday and Sunday had eliminated practically all elements of danger from the banking situation.” — Wall Street Journal
- October 21: Knickerbocker Trust Company asked Charles Barney to resign. News spread of Barney’s and Knickerbocker’s ties to Morse. The National Bank of Commerce, the Knickerbockers clearing house, said it would no longer clear for the trust. The announcement by the National Bank of Commerce presented serious concerns for Knickerbocker because of its ties to J.P. Morgan.
- October: “Nothing could be more absurd. The company was never in a stronger condition. It remains next to the largest in the city and as sound as any. There is not the slightest question of its entire solvency.” — Charles T. Barney, re: the Knickerbocker
- October 21: J.P. Morgan met with the Knickerbocker board, told them to review their books, but privately believed it was too late to save. He was more concerned about preventing a further spread to other trust companies. The Knickerbocker board decided to open for business the next day.
- October 22: A line of people waited outside the Knickerbocker before it opened. Within 2.5 hours, the trust returned $8 million to depositors at two main locations and two small branches. The Knickerbocker suspended operations at noon. Right before the suspension, it was flooded with large checks from other banks. Benjamin Strong reviewed the trust company’s books and reported to Morgan that it was insolvent.
- October 22: The suspension of the Knickerbocker sent shockwaves through the stock market. Call money rates quoted at 10% at the open, shot up to 70% by the close. Banks hoarded their cash, rather than lend it.
- October 22: “I think it is safe to say that no other financial institution of the least importance will have to undergo the experiences of the Knickerbocker Trust Company. I feel optimistic for the first time since these troubles began.” — NYCH committee member
- October 22: “I believe the general banking conditions will continue to improve from now on. The trouble at its origin was due to peculiar methods of certain parties who have now been forced out of the situation and the clearing house will continue to render such assistance as may be necessary.” — A. Barton Hepburn, president of Chase National Bank
- The Trust Company of America
- October 22: Also experiences heavy withdrawals. Morgan had Strong review the Trust Company books and his report came back positive.
- “I was satisfied that the company was solvent; that I thought their surplus had been pretty much wiped out; but that the capital was not greatly impaired, if at all, although were the company to be liquidated there were many assets which it would take some years to convert into cash.” — Benjamin Strong
- “This is the place to stop the trouble.” — J.P. Morgan
- Morgan called a meeting of the 10 largest trust company presidents to put it to them to stop the run. He asked each to pledge $300k — $3 million total — to help the Trust Company. The president’s refused.
- At the last minute, Morgan reviewed the most valuable securities held by the Trust Company, contacted the presidents of the two largest banks in the city, and used the securities as collateral for a $3 million loan. It was enough to keep it open the rest of the day.
- Late that evening Morgan again met with the presidents of the trust companies to ask them to pledge $10 million to help stop the run. They balked again. Finally, Morgan went around the room, asked each president how much they would pledge, and got a total of $8.25 million to be loaned the next morning to the Trust Company of America.
- October 23: The trust presidents had a change of heart and refused to loan the $8.25 million to the Trust Company. Morgan told Strong to use the remaining Trust Company securities as collateral for a loan from National City Bank. Strong exchanged the securities for cash, then raced to the Trust Company before it opened. It was saved again.
- October 24: Newspapers exalted Morgan as the savior of the city. U.S. Treasury Secretary offered $25 million in liquidity for the crisis. John D. Rockefeller Sr. deposited $10 million in the Union Trust Company and pledged an additional $40 million if needed.
- October 24: Trust companies were doing everything to save themselves at the risk to the rest of the system. They called in loans and sold securities to hoard cash. Security sales sent stock prices tumbling. The combination of falling prices and no money being lent risked upwards of 50 brokerage houses might fail. The president of the NYSE approached Morgan for a $25 million loan. Morgan again turned to 14 banks to create a pool to cover the loan. The pool was organized and lending within minutes before the market closed.
- October 24: “If people will keep their money in the banks, everything will be all right.” — J.P. Morgan to reporters that evening
- October 25: The prior day’s panic was repeated. Trust companies continued to call in loans and sell securities to save themselves, despite Morgan’s pleading to stop. Margin loan rates spiked to 150%. Morgan again asked the largest banks to create a lending pool to save the brokerage houses from widespread failure. This time he insisted that the cash could only be sued for investments (no margin sales) and the pool would only be available in the afternoon.
- October 25: No brokerage houses failed. Seven banks failed that day. Savings banks instituted a requirement of 60-day notice for withdrawals.
- October 25: That evening, Morgan and his team created a PR committee to reassure the public and another committee to reach out to local clergy to encourage congregations over the weekend.
- October 26: “Above all, let no man or woman selfishly lock their hoardings in private security…but let them bring forth their surplus and add it to the public exchequer, so as to relieve the present famine in the money market.” — Andrew Carnegie
- October 27: “We have seen the worst of the ‘panic’ phase, and it has to be remembered that the crisis, at any rate, so far as it is connected with extraordinary trade activity, constitutes only a striking example of a complaint common in almost every financial centre, namely, a growth in the demands upon capital out of proportion to the supply.” — Standard of London
- October 27: “By their action they did invaluable service in checking the panic which, beginning as a matter of speculation, was threatening to destroy the confidence and credit necessary to the conduct of legitimate business. No one who considers calmly can question that the underlying condition which make up our financial and industrial well-being are essentially sound and honest. Dishonest dealing and speculative enterprise are merely the occasional incidents of our real prosperity. The action taken by you and by the business men in question has been of the utmost consequence and has secured the opportunity for the calm consideration which must inevitably produce entire confidence in our business conditions.” — President Teddy Roosevelt
- October 28: The NYCH issued $100 million in clearing certificates to its 53 member banks, injecting massive liquidity into the system. Morgan originally was against it but approved once plans to use certificates in other major cities became known. The stock market took the news well. Margin loan rates dropped to 6% by the close.
- October 29: Morgan solved a problem for New York City. The city was out of money and needed to raise $30 million to pay workers. “Morgan had crafted a proposal that J. P. Morgan & Company would take $30 million of the city’s revenue bonds, with optional terms of one, two, or three years, bearing an interest rate of 6 percent. There was an option on $20 million more, and the city was required to appoint a commission to examine its finances. Morgan planned to exchange these bonds for clearing-house certificates by handing them over to the First National and National City Banks. This measure would thereby result in an additional $30 million in liquidity for the City of New York as well as provide $30 million in credit for the city through the banks.”
- October 30: Trust Company of America saw a day of inflows — over $100,000 more in deposits than withdrawals. The bank run was over.
- Moore & Schley and Tennessee Coal, Iron & Railway Company
- November 2: Morgan called an emergency meeting. The last major problem to arise was the potential failure of the brokerage firm, Moore & Schley.
- Moore & Schley used shares of Tennessee Coal, Iron & Railroad Company (TC&I) as collateral to secure loans. TC&I was falling in price, jeopardizing those loans. Should the loans be called, the TC&I shares would be sold, tanking the share price, and putting Moore & Schley at risk of failure. It could reignite the crisis.
- “It is very serious. If Moore and Schley go, there is no telling what the effect on Wall Street will be and on financial institutions of New York, and how many other houses will drop with it, and how many banks might be included in the consequences.” — J.P. Morgan
- The attorney for TC&I suggested to Morgan that U.S. Steel could save the day by buying TC&I. Morgan liked the idea and gathered U.S. Steel’s finance committee to discuss it.
- U.S. Steel offered to loan Moore & Schley $5 million or buy control of TC&I for $90/share cash. Grant Schley turned down the initial proposal.
- November 3: “Morgan asked Joyce how much he estimated would be needed for Moore & Schley to avoid ruin. “About seventeen or possibly eighteen millions, sir,” Joyce responded. With that, Morgan proclaimed that the three of them—himself, Baker, and Stillman—must raise the money at once; he announced he would take a third interest in the subscription, and he suggested that Baker and Stillman provide the remainder of the $18 million, which would be carried by their banks until U.S. Steel could arrange to take it over from them.
- U.S. Steel’s second proposal to buy a majority of TC&I would exchange a U.S. Steel 5% gold bond (60-year) for 100 shares of TC&I stock. The deal was contingent on three conditions: 1) the Roosevelt administration agreed to it, 2) it must save Moore & Schley, and 3) it must attend to the trust companies’ struggles. Schley agreed. It was only a matter of getting the President’s approval.
- November 4: Elbert Gary and Henry Clay Frick from U.S. Steel met with the President to get his approval, to avoid an antitrust lawsuit. The President approved it.
- “The relief furnished by this transaction was instant and far-reaching. Institutions, whose solvency might at any moment have become impaired through the continued possession of Coal & Iron stock among their assets, have been reinstated through the conversion of the stock into bonds of the Steel Corporation. Accordingly, now their standing cannot be open to question or the object of suspicion.” — Commercial and Financial Chronicle
- November 4: The market rallied on the news. It was the best day since before the crisis began.
- About $250 million in clearing certificates were issued at the peak of the crisis, roughly equal to 14% of all currency in the system. Scrips and IOUs were also used due to the shortage of cash.
- “All told, during the panic about $350 million in deposits were withdrawn from the U.S. financial system. Of this amount, the bulk of it was simply socked away—estimates of cash hoarding ranged from $200 to $296 million.”
- Partial suspension of withdrawals spread throughout the country by the end of the crisis. Legal holidays were declared in some states to close the banks. Other states resorted to limiting withdrawals to small amounts.
- “Only six of 6,412 national banks failed in the panic, fewer than in any other panic of the National Banking era.”
- 25 banks and 17 trust companies failed in the crisis.
- “Commodity prices fell 21 percent, eliminating virtually the entire increase from 1904 to 1907. Industrial production dropped more than in any other U.S. panic up to 1907. The dollar volume of bankruptcies declared in November spiked up by 47 percent over a year earlier—the panic would be associated with the second worst volume of bankruptcies up to 1907. Gross earnings by railroads fell by 6 percent in December, production fell 11 percent from May 1907 to June 1908, wholesale prices fell 5 percent and imports shrank 26 percent. Unemployment rose from 2.8 percent to 8 percent, a dramatic increase in a short space of time.”
- The stock market dropped 37% from its September 1906 peak to the bottom of the crisis in November 1907.
- “It is probably no exaggeration to say that the industrial paralysis and the prostration was the very worst ever experienced in the country’s history.” — Commercial and Financial Chronicle
- The crisis took on a global scale, leading to financial crises in Eqypt, Hamburg, Chile, Holland, and Copenhagen.
- “In January 1908, banks finally lifted their suspension of payments. The subsequent recession ended in June 1908, followed by buoyant economic growth in the United States for the next 18 months. By late 1909, the stock market and industrial production recovered to prepanic levels and the economic cycle peaked in January 1910.”
- The Aldrich-Vreeland Act was passed by Congress on May 30, 1908. It set up an emergency currency scheme to issue funds based on bank reserves. It also created a commission to study the U.S. financial system. Its final report, issued in 1910, included a design for a National Reserve Bank — a design for The Federal Reserve System.
- ” I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation and then by deflation, the banks and the corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.” — Thomas Jefferson
- Congress passed the Federal Reserve Act on December 22, 1913. It created the Federal Reserve Banks. Benjamin Strong was named the first governor of the Federal Reserve Bank of New York.
- “The operations of so comprehensive a system of concentration necessarily developed in the bankers overweening power. And the bankers’ power grows by what it feeds on. Power begets wealth; and added wealth opens ever new opportunities for the acquisition of wealth and power. The operations of these bankers are so vast and numerous that even a very reasonable compensation for the service performed by the bankers, would, in the aggregate, produce for them incomes so large as to result in huge accumulations of capital… We must break the Money Trust or the Money Trust will break us.” — Louis Brandeis
- Two features of the financial system are the basis for crises:
- A complex dynamic system naturally produces unpredictable outcomes. Positive and negative feedback loops, time, the participants, and more determine how the system behaves.
- Information asymmetry means that some people in the system have more information than others and can use that to their own advantage.
- “Every major financial panic has occurred after an episode of rapid economic growth though not all panics are associated with recessions. Of special interest is not the fact of growth, but rather the cause of the inflection, the downturn from boom to slump. Rapid economic growth creates a demand for money that eventually imposes liquidity strains on the financial system.”
- “Market liquidity, or the lack thereof, is a primary element—perhaps the primary element—in determining the length and severity of a panic.” — Glenn Donaldson, economist
- “Both the panic and the boom are eminently psychological phenomena. This is not saying that the fundamental conditions do not warrant sharp declines in prices and at other times equally sharp advances. But the panic, properly so-called, represents a decline greater than is warranted by conditions usually because of an excited state of the public mind accompanied by exhaustion of resources; while the term “boom” is used to mean an excessive and largely speculative advance… It is really astonishing what a hold the fear of a possible panic has on the minds of many investors. The memory of the events of 1907 undoubtedly operated greatly to lessen the volume of speculative trade from that time to the present.” — G.C. Seldon, The Psychology of the Stock Market
- Prisoner’s Dilemma — A game theory paradox that produces a suboptimal solution when two people make decisions in their own self-interest. Bank runs are a prime example, where depositors chose to withdraw their money over the common good, which creates a negative feedback loop resulting in a run on the bank. It also happens during a market panic as sellers rush to sell.
- “The classic problem of bank risk management is to achieve an always elusive degree of leverage that creates an adequate return on equity without threatening default. The success rate has never approached 100 percent.” — Alan Greenspan
- “The real causes of all the trouble can be summed up as follows: (1) the high finance manipulation in advancing stocks to a 3.5 to 4 percent basis, while the money was loaning at 6 percent and above, on six and twelve months, time on the best of collaterals; (2) capital all over the nation having gone largely into real estate and other fixed forms, thereby losing its liquid quality; (3) the making of injudicious loans by the Knickerbocker Trust Co., hence suspension; (4) the unloading by certain big operators of $800,000,000 of securities, following which were the immense sales of new securities by the railroads; (5) the California earthquake, with losses amounting to $350,000,000; (6) the investigation of the life insurance companies; (7) the Metropolitan Street Railroad investigation; (8) the absurd fine by Judge Landis of $29,400,000 against a corporation with a capital of $1,000,000; (9) the Interstate Commerce Commission’s examination into the Chicago & Alton deal and the results thereof.” — Henry Clews, Fifty Years in Wall Street
