The Panic of 1907: Lessons Learned from the Market’s Perfect Storm
Robert Bruner and Sean D Carr
John Wiley & Sons
One hundred years on must have seemed like a good time to re-visit one of Wall Street’s most severe financial panics. That, presumably, is why Robert Bruner and Sean D. Carr sat down to write The Panic of 1907. But the authors could hardly have expected that another global credit crisis should suddenly appear just as their own work hit the bookstands. Anyone who needs convincing that financial history is constantly repeating itself should peruse this timely tome.
A century ago, the US economy was expanding at a pace comparable with China’s today. New York was replacing London as the world’s financial capital. In 1901, several steel concerns were amalgamated to create US Steel, the world’s largest company.
The financial journalist Alexander Dana Noyes remembered the stock-market boom at the beginning of the century as ‘the first of such speculative demonstrations in history which based its ideas and conduct on the assumption that we were living in a New Era; that old rules and principles and precedents of finance were obsolete; that things could safely be done today which had been dangerous and impossible in the past’.
Still, not all was bright in 1907. In April of the previous year, an earthquake and fire had destroyed the city of San Francisco. The damage was estimated at around two per cent of the country’s national income. Funds for reconstruction arrived from around the world. But as gold flowed to the United States, it became less available elsewhere. The Bank of England responded by raising its lending rate to six per cent in late 1906, its highest level in nearly a decade. In order to staunch the export of gold, the Bank later banned the issue of US finance bills in London.
To make matters worse, Teddy Roosevelt’s ‘progressive’ administration was deeply antagonistic to Big Business. By 1907, Roosevelt’s Justice Department had sued nearly 40 corporations under the Sherman Antitrust Act. Roosevelt identified the ‘predatory man of wealth’ as the chief threat to the future of the United States. Wall Streeters weren’t unduly perturbed by this bluster. Most expected that the worst was over after the stock market slipped and declined mildly in the spring of 1907.
Like most great panics, the trigger was seemingly innocuous. In early October, an attempt was made by a group of unscrupulous operators to ramp the shares of a mining company, United Copper. Attempts to ‘corner’ stocks were not uncommon at the time. But this one failed and its failure brought down a couple of small brokerage houses.
The contagion began to spread. The brother of one of the bankrupt brokers, F Augustus Heinze, was asked to leave the board of a bank he controlled in New York. Heinze was associated with a shady Wall Street character, named Charles Morse, who had interests in several banks. They, in turn, came under suspicion and he was forced to sever his ties.
The panic next spread to the trust companies. These institutions resembled banks in that they took deposits from the public. But like hedge funds today, they were largely unregulated and weren’t obliged to keep the same level of reserves as conventional banks. Unlike banks, they were allowed to invest directly in the stocks and unlisted securities.
Owing to their low level of reserves and riskier investments, the trust companies paid depositors higher rates. But these deposits were repayable on demand, while many of the trusts’ assets were illiquid; that is, it took time to turn them into cash, while a forced sale was likely to push down their valuations.
The Knickerbocker Trust was the second largest trust company in New York. It had grown very rapidly under the management of Charles T Barney and occupied an imposing building on 34th Street and 5th Avenue, adorned with four 17-ton Corinthian columns. Although the company was solvent, Barney had business ties with Morse. He resigned from the board, but that didn’t stop the depositors from lining up to withdraw their money. Bank runs were relatively common at the time. If others were taking their money out, there was no sense in hanging back.
On Tuesday 22 October, the Knickerbocker suspended payments. The alarm spread to other trust companies, and then to banks across the country. Cash was hoarded and money became in such short supply that the call money rate, for lending against stock, climbed to over 100 per cent. The stock market swooned. By 24 October, Noyes described an ‘almost complete suspension of credit in the financial markets’. Many companies closed, or went on half-time, for lack of means to pay their workers.
The leading American banker Pierpont Morgan was out of town attending the Triennial Episcopal Convention when the run on the Knickerbocker started. But this financial ‘Jupiter’ soon returned to impose order on the unruly denizens of Wall Street. Morgan persuaded the unwilling trust company presidents and other bankers to provide a pool of money to aid solvent firms that came under suspicion.
Eventually, the panic subsided. After a short sharp recession, the economy rebounded and before the end of the decade the Dow Jones was climbing to new heights. A few years later, the Federal Reserve was established to institutionalise the role of crisis-fixer played by the ageing and irreplaceable Morgan.
Bruner and Carr relate this story well. Their conclusions are sound and perceptive, if at times rather mundane: they stress in particular ‘the importance of transparency… the encouragement of collective actions, the establishment of safety buffers in the global financial system, and the duty of leaders to serve their constituencies’.
This summer’s credit crisis has followed a similar, if somewhat less dramatic, course. The blow up at a hedge fund run by Bear Stearns in New York created a contagion of fear which spread around the world, eventually sparking the first bank run in England for near 150 years. As it turned out, the lesson of 1907, and just about every other banking panic in history, had been forgotten: those who borrow short and lend long may enjoy fat profits in good times, but they are vulnerable to a change in market sentiment.
Noyes believed the crisis of 1907 wasn’t primarily caused by the unsound practices of the trust companies. Rather, he blamed it on an insufficiency of capital, or savings, following a period of strong economic growth around the world. Cairo had already experienced a panic in the spring of that year, and there were also disturbances in Hamburg prior to the eruption on Wall Street. ‘The strain on the financial world was of so severe a character,’ wrote Noyes, ‘that it was bound to result in a break in the chain of credit, wherever the link was weakest or the strain was greatest… the strain was incalculably greatest in New York, where credit had been so grossly abused.’
This summer’s credit crunch has not been as severe at its counterpart a century earlier because cash today is never scarce. In an age of fiat currencies, money can be manufactured by central banks at no expense. Furthermore, there is no apparent shortage of capital. Countries with large export surpluses – from the Persian Gulf states to China – continue to recycle their surpluses to the United States and elsewhere. ‘Capital is infinite’, commented the chief executive of General Electric recently. Long may that illusion last.
Review by Edward Chancellor