Panic of 1907
The Panic of 1907, also known as the 1907 Banker's Panic, was a financial crisis in the United States. It primarily affected bankers but sharply depressed the manufacturing sector for a year. It underscored the need for a thorough reform of the banking system, which was accomplished by the creation of the Federal Reserve System in 1913.
The recovery from the depression of 1893 was maintained by speculation and investments in merging and expanding corporations. The currency supply was expanded by new discoveries of gold in Alaska, South Africa, and Colorado, and from the use of new extraction and reclamation technologies. Nonetheless, the currency supply was not expanding as quickly as the economy. The short-fall for a while was made up by gold transfers from European banks. By 1906, European bankers had turned bearish on this steady drain on their gold reserves and increased their interest rates (The Bank of England for example raised its discount rate from 3.5% to 6% between August and November 1906). This reversed the flow of gold. Investors in the US grew bearish as well, the stock market topped and began to decline. The falling stock market affected US business confidence and production slowed.
The stock market fell nearly 50% from its peak in 1906, and there were numerous runs on banks and trust companies. Its primary cause was a credit crunch that began on Wall Street and soon spread across the nation, leading to the closings of banks and businesses. It was the fourth panic in 34 years, and the first since the much worse Panic of 1893. Unlike 1893 it did not throw the nation into a depression.
Troubles mounted in summer 1907. U.S. Steel, by far the largest industrial corporation, reported an sharp drop in business; railroad earnings began to sag; the money market tightened up, making it difficult to raise large sums and leading to fears that it would be difficult to finance the fall harvest of major crops. The collapse of Charles W. Morse's shipping combination added to anxiety as did the failure of the City of New York to sell its bonds in Wall Street. In early October came the failure of the whole Heinze-Morse chain of banks and the National Bank of North America. Runs on the Knickerbocker Trust Company, the Trust Company of America, the Lincoln Trust Company, and a dozen other financial institutions forced them to close their doors. Each disaster had repercussions in other major cities and pulled down private firms and brokers. The accompanying panic in the stock market completed the havoc. By late October the panic was on.
Trust companies rather than the banks were the key to the panic. Since 1898 they had quadrupled in size because ordinary banks were required by law to maintain large cash reserves but trust companies were not. With only 2% or 3% of their assets lying idle in the form of cash, trust companies could afford to pay high interest rates to depositors. Suddenly, with the collapse of the Knickerbocker Trust, depositors became frightened. Trust companies, with their low reserves, would be hard pressed to cover their accounts by even a moderate panic among their depositors. Still worse, there was no organization among them comparable to the Clearing House, which operated as a bulwark of mutual defense for hard-pressed banks.
To bring relief to the situation, Treasury Secretary George B. Cortelyou earmarked $35 million of Federal money to quell the storm. Banker J.P. Morgan now took personal charge, meeting with the nation's leading financiers with a plan to meet the crisis. James Stillman, president of the National City Bank, also played a central role. Morgan organized a team of bank and trust executives which redirected money between banks, secured further international lines of credit, and bought plummeting stocks of healthy corporations. A delicate political issue arose regarding the brokerage firm of Moore and Schley, which was deeply involved in a speculative pool in the stock of the Tennessee Coal, Iron and Railroad Company. Moore and Schley had pledged over six millions of the Tennessee Coal and Iron (TCI) stock for loans among the Wall Street banks. The banks had called the loans, and the firm could not pay. If Moore and Schley should fail, a hundred more failures would follow and then all Wall Street might go to pieces. Morgan decided they had to save Moore and Schley. TCI was one of the chief competitors of U.S. Steel and it owned valuable iron and coal deposits. Morgan controlled U.S. Steel and he decided it had to buy the TCI stock from Moore and Schley. Judge Gary, head of US Steel, agreed, but would there be antitrust implications that could cause grave trouble for US Steel, which was already dominant in the steel industry? Morgan sent Gary to see President Roosevelt, who promised legal immunity for the deal. U.S. Steel thereupon paid $30 million for the TCI stock and Moore and Schley was saved. The announcement had an immediate effect; by November 7, 1907, the panic was over.
Impact on the economy
By February 1908, full confidence in the banking system was restored. However the panic hindered the economy in several ways. First, it slowed economic growth by temporarily undermining general confidence in the economy. Investors became hesitant. Second, the shortage of cash induced banks to postpone their loan services temporarily. Third, the substitution of clearinghouse certificates for cash dislocated domestic exchange; certificate exchange rates varied, preventing banks from accepting certificates from outside their locality. Finally, the shortage of currency deprived manufacturers of resources to pay wages and salaries, and many temporarily shut down their operations or reduced their production hours. Some went bankrupt. These reverberations delayed economic recovery until 1909, ten months after the currency shortage had been resolved. Internationally the panic severely impacted Mexico and helped spark its revolution and civil war.
The dislocation of domestic exchange and the suspension of loans triggered an economic downturn in every sector of the economy. In 1906 aggregate business failures totaled $119 million. In the next two years liabilities grew to $197 million in 1907 and $220 million in 1908, mostly in manufacturing. Production levels declined radically as well. The Miron and Romer Index of industrial production reveals that production levels dropped from 93 in October 1907 to 71 in December, remained below 80 until July 1908, and did not exceed 90 until the November 1908. The decline in production also affected foreign trade as 1908 imports and exports fell by 22% and 9%. Unemployment levels increased from 3% in 1907 to 8% in 1908. Reviewing the financial conditions of 1908, a leading business journal, The Commercial and Financial Chronicle, concluded:
- "In trade and mercantile affairs the year of 1908 was one of intense depression, relieved only by partial recovery the latter part of the year. 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."
Impact on banking and antitrust policy
In May 1908, Congress passed the Aldrich-Vreeland Act which established the National Monetary Commission to investigate the panic and to propose legislation to regulate banking. Senator Nelson Aldrich and a team of experts toured Europe and were astounded how much better the European systems worked, thanks to their central banks. They proposed what became the federal Reserve System. It was impossible, however, to pass any legislation proposed by bankers as the Democrats took control of Congress in 1910.
Antitrust policy was significantly affected as the panic gave momentum to trust-busters in Washington. In his last two years as President Theodore Roosevelt had his Justice Department bring suits against numerous industrial trusts, notably Standard Oil and American Tobacco. Roosevelt felt confident that he personally could decide which trusts were "good" and which "bad." When William Howard Taft became President in 1909, he disagreed sharply with Roosevelt's personal intervention, leading to a personal break and a split in the Republican party in 1912.
The monetary and antitrust issues were finally resolved by President Woodrow Wilson in 1913 with passage of the Federal Reserve Act, which created a central banking system to dampen the effects of future panics. The Clayton Act (1914) and Federal Trade Commission (1914) set out clear new guidelines for antitrust that no longer depended on presidential opinions.
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- Carosso, Vincent P. The Morgans: Private International Bankers, 1854-1913 (1987).
- Friedman, Milton, and Anna J. Schwartz. A Monetary History of the United States: 1867-1960 (1963). excerpt and text search Portions also available on GoogleBooks.
- Garraty, John A. Right-Hand Man: The Life of George W. Perkins (1960), ch. 11. online edition
- Moen, Jon, and Ellis W. Tallman. "The Bank Panic of 1907: The Role of the Trust Companies." Journal of Economic History 52 (September 1992): 611-630. in JSTOR
- Moen, Jon, and Ellis W. Tallman. "Clearinghouse Membership and Deposit Contraction during the Panic of 1907," The Journal of Economic History 60, No. 1 (March 2000): 145-163. in JSTOR
- Moen, Jon. "Panic of 1907." EH.Net Encyclopedia, edited by Robert Whaples. August 15, 2001. online version
- Moody, John. The Masters of Capital: A Chronicle of Wall Street (1921), popular; ch 8, pp 131–54. online edition
- Noyes, Alexander D. "A Year After the Panic of 1907," Quarterly Journal of Economics (1909) 23#2 pp. 185–212; stress on international economy; in JSTOR
- Noyes, Alexander D. Forty Years of American Finance: A Short Financial History...1865-1907 (1909) online edition
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- Friedman and Schwartz, 137.
- Jeremy Atack and Peter Passell, A New Economic View of American History: From Colonial Times to 1940, 2d ed. (1994), 516.
- See Moody (1921) 143ff
- Garraty, 1960 pp 207-9
- Moen and Tallman (1992)
- The episode politically embarrassed Roosevelt for years. Garraty, 1960 ch. 11
- Sprague (1908); Cahill (1998)
- Cahill (1998)