The Panic of 1907 came after the 1906 San Francisco Earthquake which actually exposed the entire problem of regional internal capital flows within the United States caused by the business cycle and the great variety of localized economies. While the traditional accounts of the Financial Panic focus on as crisis that took place over a three-week period starting in mid-October, when we look more objectively, we see that the market had already reached a high on September 6th and a decline was in full motion.
Banks evolved from merely being a place of secure storage (no leverage) into a lending institution where fractional banking took place. Once “credit” is introduced, the velocity of money increases expanding economic growth but the money supply becomes leveraged. Banks traditionally take deposits on a demand basis but lend out about 92% of those deposits even multiple times typically at the longer-term of the yield curve. This means that the short-term rates are below long-term and that becomes the main profit source for relationship banking where the bank knows and trusts its clients.
A banking panic takes place when depositors suddenly want to withdraw their MONEY, but since the bank has lent it to someone else on a longer-term, this is when the banks will fail due to the fact that they are engulfed in a liquidity crisis. They cannot meet the immediate demand to withdraw deposits.
Indeed, such a period of a temporary shortage burst forth during the Panic of 1907 and it was John Pierpont Morgan (“JP”)(1837-1913) who saved the day, although most have criticized him ignoring his great patriotism and contribution to the country. The Panic began when there was an attempt to manipulate the market in United Copper Company that was a short squeeze which backfired. This was the catalyst, not the cause. It was the spark that ignited the Panic that took place. They borrowed money to buy stock to create the squeeze from the Knickerbocker Trust and suddenly they could not pay back their loans bringing the bank into failure. J.P.
Morgan gathered his associates to examine the books of the Knickerbocker Trust but found it was insolvent and decided not to intervene to stop the run. When it became clear the Knickerbocker Trust would fail, the run spread to other banks and a contagion grew.
The Trust Company of America asked Morgan for help. Morgan now brought in First National Bank and National City Bank of New York (later Citi Bank), and the US Secretary of the Treasury. Morgan had a quick audit of the bank and declared that this was where to defend. As the run began, Morgan worked with his associates to sell the assets of the bank to free up cash for the depositors. The bank survived the close of business.
Morgan knew that this collapse in CONFIDENCE would not the end by just saving the Trust Company of America. Morgan now summoned the heads of various banks in New York and kept them until they agreed to provide loans of $8.25 million. Morgan convinced the Treasury to deposit $25 million in NY banks. John D. Rockefeller, the wealthiest man in America deposited $10 million with City and called the Associated Press to announce his pledge to help the NY banks. Nonetheless, the New York banks then, as now, proved to be their worst enemy. Despite the efforts of Morgan to create this infusion, they were reluctant to lend any money for short-term stock trading. The stock market crashed. By 1:30 pm Oct 24th, the president of the NYSE went to tell Morgan the exchange would close early.
Morgan was livid. He understood that this would reinforce the Panic and he drew the line and would not allow it. Morgan warned that if the NYSE closed early, it would be catastrophic to say the least. Once again he summoned the bankers who arrived by about 2pm and Morgan pretty much yelled at them and warned that as many as 50 stock brokerage firms would fail unless $25 million was now raised in 10 minutes! By 2:16 pm, 14 banks pledged $23.6 million to keep the stock exchange alive. The money even reached the exchange by 2:30 pm, to finish trading at 3pm. The amount that was actually needed was only $19 million. Morgan himself hated the press that rarely treated him fairly, but this time he gave a rare comment.
The next day, the NYSE needed more money and Morgan this time could only raise $9.7 million. Morgan directed the NYSE that the money could not be used for margin sales. The exchange made it to the close. Morgan knew he had to turn the minds of the people and to restore their critical CONFIDENCE to stop the Panic. Morgan now directed two committees to be formed to (1) persuade the clergy to preach calm to their congregations on Sunday, and (2) to sell the idea of clam to the press. Morgan was desperately trying to hold the nation together. Unknown even to his associates, the City of New York could not raise money through its bond issue and it informed Morgan that it needed $20 million by November 1st, 1907, or it would go into bankruptcy. Morgan himself contracted to purchase $30 million in New York City bonds.
On November 2nd, one of the largest stock exchange brokers, Moore & Schley, was heavily in debt using the Tennessee Coal, Iron & Railroad Co stock as collateral. The stock was thinly traded and the stock was under pressure. Their creditors would now surely call their loans. Morgan called another emergency meeting and a proposal was put forth that US Steel Corp, would acquire the stock in bulk. Yet another crisis was looming. Runs were now likely to hit two banks on Monday. Morgan summoned 120 banks and told them he would not proceed with the US Steel deal unless they supported the banks.
Morgan now locked them in his library and told them they had to come up with $25 million to save the banks. It took almost 2 hours. Morgan finally convinced them that they had to bailout the banks to save their own skins. They signed the agreement, and he unlocked the doors and let them leave.
Morgan was saving the nation again, singlehandedly. He then turned back to save the NYSE. He knew the problem would be the Marxist inspired Antitrust Laws (Sherman Antitrust Act), and the crusading Marxist/Progressive President Teddy Roosevelt (1858-1919). Breaking up companies he believed were monopolies was the main focus of Roosevelt’s administration. To save the day, he would have to see that the Antitrust Laws must yield.
Two men thus traveled to the White House to implore Roosevelt to set aside his Antitrust Laws to save the nation. As typical, Roosevelt’s secretary refused to let them in to even discuss the problem. The two men, Frick and Gary of US Steel turned to James Garfield who was Secretary of the Interior at that time. They pleaded with him to go to the President directly. Garfield had convinced Roosevelt to at least review the proposal. Roosevelt was for the first time forced into a corner. He had to realize a collapse of the NYSE would take place if he did not yield in his ant-corporate beliefs. Roosevelt later lamented:
“It was necessary for us to decide on the instant before the Stock Exchange opened, for the situation in New York was such that any hour might be vital. I do not believe that anyone could justly criticize me for saying that I would not feel like objecting to the purchase under those circumstances.”
Following the near catastrophic financial disaster known as the Panic of 1907, the movement for banking reform picked up steam among Wall Street bankers, Republicans, and a few eastern Democrats. However, much of the country was still distrustful of bankers and of banking in general, especially after Panic of 1907. After two decades of minority status, Democrats regained control of Congress in 1910 and were able to block several Republican attempts at reform, even though they recognized the need for some kind of currency and banking changes. As always, it was more important to further political party power than actually do the right thing for the nation.