Financial crises have been around longer than many realize. Imagine reading that the stock market plunges by 50%, recession follows, investment firms and banks fail across the country, and the government seeks to get to the bottom of what happened. Could that be describing the Great Depression or the most recent recession? In either case, it certainly could. But it could also fit the description of the Panic of 1907 and many others before or since.
Especially in the US, it seems that the historical memory of the Great Depression so greatly overshadows earlier crises, such as those financial panics of the 19th and very early 20th centuries, that we forget about them entirely. Alright, perhaps we remember their years. Yes, 1873 was a bad year, as was 1893; but do we know what caused them? At most, we can name railroad speculation as a factor. Of the Panic of 1907, the legendary intervention of J.P. Morgan (the man more so than his firm) is perhaps the only event of that crisis that is recounted. But two other features of that crisis, that of the Knickerbocker Trust Company and the National Monetary Commission which followed the panic, are important to recall.
Established as a bank in 1884, the Knickerbocker Trust Company was the firm whose near collapse triggered the Panic of 1907. It had grown rapidly in the preceding decade. In just the ten years before the crisis, the bank grew from $10 million in deposits to $61 million. This growth occurred under the leadership of the Bank’s then president, Charles Tracy Barney.
Knickerbocker was a New York City based trust company. New York trust companies operated like banks, as a financial intermediary offering deposit accounts. Depositors could request withdrawals of their balances on demand. However, trust companies differed from ordinary banks in two respects; they did not offer the kind of payment and check-clearing services that other banks offered and because they were not integral entities in the nation’s payment system and thus saw fewer transactions, they generally held less cash on reserve. Whereas a post-crisis commission found that New York banks had averaged a 25-27% ratio of cash reserves to deposits, reserve ratios for trusts were more like 5%.
So how had the bank gotten into trouble? The story involves two brothers and their plan to corner the market for shares of the United Copper Company. Otto and Augustus Heinze, along with another prominent business partner, attempted to buy enough shares that other potential buyers, such as those who needed to cover short positions, would have to pay a premium.
As the two speculators bought up all the shares they could, prices surged. However, insufficient shares were purchased to successfully corner the market; the short sellers the brothers tried to squeeze had no trouble buying shares at lower prices from others with which to cover their short positions. Prices for the shares fell precipitously, reversing their earlier gains as the Heinze brothers bought the shares, and the price eventually fell further, to a fraction of their initial value. The plan had failed and Otto and Augustus Heinze incurred large losses; among the lenders believed to be financing their scheme was the Knickerbocker Trust.
As soon as news of the failed scheme spread, banks associated with the Heinze brothers suffered bank runs as depositors feared the losses would be too great for those who lent the speculators money to survive. In actuality, though the Heinze brothers had asked Charles Barney for financial backing for their venture, the Knickerbocker Trust had not lent them money. However, Barney was viewed as closely associated with the brothers and so many suspected the trust was among their lenders anyway; there was a run on the bank.
Panic of 1907
On October 22nd 1907, the Knickerbocker Trust experienced $8 million in withdrawals, exhausting the trust’s reserves. Police had to be called in to handle the crowds and the bank shut early that day, just pass noon, leaving many depositors waiting outside in line. Fearing that the run would spread, another banker took action.
While John Pierpont Morgan believed that the Knickerbocker Trust was insolvent and thus not worth saving, the crisis began to spread to other trust companies. There was also a run on the Trust Company of America and this did worry Morgan, the city’s preeminent banker. A spreading crisis meant that no bank would be trusted. A measure of trust between financiers and the stability of the markets in those days was the rate offered on loans backed by shares of stock. Data from the New York Times shows that when the Knickerbocker Trust closed on October 22nd, the rate offered on loans backed by stock collateral soared from 9.5 percent to about 100 percent in two days.
Unlike the Knickerbocker Trust, the Trust Company of America was solvent but experienced a run throughout the day following Knickerbocker’s closure. With the cooperation and assistance of other lenders, the Trust was able to liquidate its assets without a disorderly fire sale that day. Then on October 24th, Morgan led a consortium of banks in his library which arranged a loan of over $8 million for the Trust Company of America. This was followed by other action taken by the U.S. government and John D. Rockefeller; thus, by organizing these actions, J.P. Morgan halted the worst of that financial crisis.
As it happens, the Knickerbocker Trust would actually survive the Panic of 1907 but only by remaining closed to customer withdrawals for several weeks. However, its name would not survive and the firm was acquired by another trust company a few years later.
National Monetary Commission
Some may know that the Panic of 1907 and the run on the Knickerbocker Trust led to the creation of the Federal Reserve System; however, perhaps equally important to the creation of the nation’s central bank was an inquiry into the monetary systems of other countries led by Senator Nelson Aldrich, called the National Monetary Commission.
The commission ended up publishing a series of papers over the period from 1909 to 1912. Some described the central banks and monetary and financial systems of other countries, including not just those of large nations like Germany and Britain, but also of Belgium, Canada, and Sweden. Other products of the Commission’s work included some, no doubt interesting, papers on “The History and Methods of the Paris Bourse” and one on “Seasonal Variations in the Relative Demand for Money and Capital in the United States.” They may not all sound equally fascinating but in the end many of Commission’s ideas were incorporated into the creation of the Federal Reserve in 1913.
An archive of the Commission’s work can be found online on the website of the Federal Reserve Bank of St. Louis. Included in this is a paper on financial crises of the late 19th century and that of 1907 titled the “History of Crises under the National Banking System.”
Economies can shift from agrarian to industrial to service-oriented, but in the history of the United States and other nations, financial crises have been potholes, indeed craters, on the road of economic development. While the source of the problems and risks involved may have been different and the forms of the relevant institutions archaic, the crises of the past are at some level relevant today.
It is worth remembering how persistent these panics are and worth recounting how they started; not because they necessarily provide a formula for resolving those of today and the future, but because they broaden our conception of the world and financial markets in particular. They refocus our attention away from conditions as they exist here and now and prod us to consider the varied outcomes of our actions and those of others. Professor Elroy Dimson of the London Business School, author of the landmark book on historical investment returns “Triumph of the Optimists,” once said “risk means more things can happen than will happen.” To the extent studying historical crises makes us sensitive to that fact, it is useful reflecting on financial panics of long ago.
1. Case Studies: Knickerbocker Trust. W.W. Norton & Company, 2004.
2. Kavoussi, Bonnie. “The Panic of 1907: A Human-Caused Crisis, or a Thunderstorm?” The Center for History and Economics.
3. Moen, Jon R., and Ellis W. Tallman. “The Panic of 1907.” Federal Reserve History, Federal Reserve, 4 Dec. 2015.
4. Sprague, O. M. W. History of Crises Under the National Banking System. Government Printing Office, 1910.