Panic of 1907

Date October-November, 1907

A run on the Knickerbocker Trust Company caused a general financial panic in the United States, precipitating intervention by a team of powerful New York bankers led by J. P. Morgan.

Locale United States

Key Figures

• J. P. Morgan (1837-1913), American financier
• James Stillman (1850-1918), American financier
• George F. Baker (1840-1931), American financier
• Theodore Roosevelt (1858-1919), president of the United States, 1901-1909
• F. Augustus Heinze (1869-1914), American copper speculator
• Charles W. Morse (1856-1933), American financial speculator and banker
• Benjamin Strong (1872-1928), secretary of Bankers Trust and a chief Morgan investigator during the 1907 panic

Summary of Event

Coming on the heels of an international liquidity crisis, a run on some of the most prominent trust companies in New York City in October, 1907, sent shock waves through the American economy. J. P. Morgan, senior partner of J. P. Morgan & Company, a private international investment bank, responded by setting up a syndicate of the most powerful banks in New York. For three weeks, his syndicate acted as a central bank by providing liquidity (ready cash) to affected trust companies. When the crisis cooled in mid-November, the financial community credited Morgan with saving the nation, even as many people criticized the power he wielded. Almost all Americans had been shaken by the panic, and the public demanded reforms of the financial system.

The seeds of the 1907 panic can be found in the world’s growing credit crunch after 1900. Sharp increases in the rate of economic growth, the number of government security issues, and the amount of stock market speculation strained the existing supply of capital, bidding up interest rates in most countries. By 1907, major bank failures occurred in Tokyo, Hamburg, Alexandria, Genoa, and Santiago. Most countries also witnessed declines in their stocks of gold, average stock prices, and money supplies as the year wore on. In some countries, including Great Britain and France, rapid central bank intervention counteracted the impending crisis by increasing liquidity, boosting the sagging confidence of the investment communities. In other countries, such as Germany, financial regulation dampened speculative activity and thus eased pressures on the money supply.

The United States, in contrast, had no central bank. More important, financial regulation was irregular or nonexistent. This was especially true in terms of the trust companies that had increasingly moved into general banking business since 1900. Banks generally faced high reserve requirements—that is, stipulations on the amount of cash they had to keep available to meet demands for withdrawals. Trust companies did not face these requirements. Because they did not need to keep so much cash on hand, cash that did not pay a return, they could offer higher rates of interest to depositors, attracting them away from banks. The trust companies then loaned these deposits out. Many borrowers used securities (stocks and bonds) as collateral for loans, which they in turn used to buy even more securities. In this way, the trust companies increased the supply of money, but on the unstable basis of financial speculation. When stock prices began to fall in early 1907 in response to international conditions, credit automatically contracted, and trust companies were forced to call in their more speculative loans, leading to further falls in the money supply.

This instability made it possible for one incident to break investor confidence and cause a major run on deposits in banks and, more significant, in the trust companies involved in speculative ventures. The incident was F. Augustus Heinze’s failed attempt to corner the copper market. Before 1906, Heinze was the owner of a copper smelter in Montana. He sold out as a millionaire, moved to New York City, and teamed up with Charles W. Morse, a bank proprietor with a notorious reputation for speculative dealing. By using their funds to buy a controlling interest in commercial banks such as the Mercantile National, Heinze and Morse gained access to large amounts of deposit funds. They used these, in turn, to gain control of trust companies unfettered by reserve and loan restrictions.

This pyramidal financial structure gave Heinze and Morse control over a vast sum of funds, which they used for speculative investments, the most important of which was their scheme to corner the copper market. When their scheme backfired in mid-October, the resulting decline in copper share prices prompted depositors to withdraw their funds. These “runs” occurred not only on banks and trust companies associated with Heinze and Morse but also on other institutions. Their main bank, Mercantile National, was saved through the intervention of the New York Clearing House. Trust companies, however, were not eligible for clearinghouse assistance, and their customers were more easily frightened into demanding the return of their deposits.

By Friday, October 18, a run had begun at New York’s third largest trust, the Knickerbocker Trust Company. All of Wall Street was aware of the fact that the trust was connected to Heinze and Morse through its president, Charles Barney. J. P. Morgan was in Richmond, Virginia, attending the Triennial Episcopal Convention when he received word about Knickerbocker Trust’s difficulties. Concerned about the possibility of runs spreading to other banks and trust companies, Morgan returned to New York a day ahead of schedule. His arrival ushered in a series of meetings, during which he put together a rescue team that included two of the nation’s most powerful bankers: George F. Baker, Morgan’s longtime financial ally and president of the First National Bank of New York, and James Stillman, Morgan’s sometime rival and president of the National City Bank (later Citibank). The purpose of the rescue team was to lend money to otherwise solvent institutions suffering runs on deposits. To determine solvency, Morgan, Baker, and Stillman put together an investigative staff led by Benjamin Strong, then secretary of Bankers Trust.

On Monday, October 21, the run continued at Knickerbocker Trust, and the institution asked Morgan’s rescue team for help. Strong was sent in to assess whether Knickerbocker was worth saving, but it was bled dry of deposits before he could complete his investigation. Knickerbocker’s failure set off runs at other trust companies, which were forced to call in their loans, many of which had been issued to brokers for speculative purposes. One indication of the extent of the problems is that when Charles Barney asked for Morgan’s help two weeks later and Morgan refused to see him, Barney shot himself.

Morgan’s rescue team stepped in to assist the Trust Company of America after Strong had judged it worthy, but others were not so lucky. As a consequence, money became so difficult to come by on Wall Street that the call (very short-term) interest rate escalated to 150 percent by Thursday, October 24. Many brokers were on the edge of bankruptcy, and trading had virtually ceased on the New York Stock Exchange. Morgan brought together a large syndicate of commercial banks that immediately made $18.95 million available for call loans at interest rates as low as 10 percent. The next day, the loans were renewed, and the syndicate issued a further $9.7 million of liquidity to Wall Street.

Morgan, Baker, and Stillman, along with their newly created banking and trust committees, then worked through the weekend trying to shore up all possible defenses. Morgan even called in the city’s religious leaders and asked them to reassure churchgoers on Sunday. On Monday, October 28, however, the unexpected struck. New York City was not able to find buyers for its warrants abroad because Europeans were withdrawing their money from American investments. The city needed an immediate loan of $30 million to avoid default by the end of the week. Morgan came up with an ingenious solution: As issuing bonds through normal channels was impossible, he arranged for Baker and Stillman each to take a portion of the bonds and turn them over to the New York Clearing House, which paid for them with certificates credited to the city’s accounts at the First National and National City Banks, controlled by Baker and Stillman.

The next week saw more trust companies and brokerage firms in trouble, including Moore and Schley, a prominent Wall Street investment house that owed $25 million. Morgan agreed to help Moore and Schley if he received something in return. The firm owned a majority of the stock of the TennesseeCoal, Iron and Railroad Company (TCI&R), and Morgan wanted United States Steel, the company he had set up in 1901, to gain control by exchanging its gold bonds for the majority stock of TCI&R held by Moore and Schley. Arguing that Moore and Schley’s failure would result in further brokerage house and trust company bankruptcies, Morgan agreed to have U.S. Steel buy TCI&R’s shares if the trust companies set up their own trust rescue fund. He then sent his U.S. Steel emissaries to Washington to tell President Theodore Roosevelt that the Moore and Schley bailout and the trust company rescue fund were contingent on a promise by the U.S. government not to launch an antitrust suit against U.S. Steel. Roosevelt agreed not to interfere, and the deal went through. The trust company rescue fund helped restore confidence, and Wall Street began a gradual recovery.

Significance

Although the financial distress of 1907 was a worldwide phenomenon, it led to a financial panic of immense proportions only in the United States. In terms of the degree of decline in credit, share prices, and output growth, as well as the number of bank and trust company failures, the United States fared far worse than did other countries. This resulted from a number of factors, including the lack of trust company and securities regulation, the lack of deposit insurance, and the absence of a central bank that could take timely preventive measures.

Reactions to the Morgan-led rescue efforts were widely divergent. On Wall Street, Morgan, Baker, and Stillman were seen as heroes who had saved the country from imminent financial collapse. Morgan, the financial community believed, had acted like a one-man central bank. Nevertheless, Wall Street and the wider financial community realized that some reforms would be needed to prevent similar panics in the future. Congress responded almost immediately by passing the Aldrich-Vreeland Act, a temporary compromise intended to make more credit available in future emergencies, and by setting up the National Monetary Commission, which had a mandate to study the defects of the existing system of finance and propose permanent solutions.

Many Americans outside the financial community, however, were concerned about both the amount of power held by Morgan, Baker, and Stillman and the manner in which they used that power. Beginning in March, 1908, Senator Robert M. La Follette of Wisconsin began a series of speeches against what he called the “money trust.” He and other Progressive politicians began to call for an investigation of the money trust and the ways in which it had abused its tremendous power. In particular, they were upset about U.S. Steel’s acquisition of TCI&R and how Morgan had personally profited from what they now called the “Bankers’ Panic.” The government, already pursuing John D. Rockefeller’s Standard Oil trust, came under increasing pressure to attack the Morgan trusts. It would take another four years, but eventually the government reacted by launching an antitrust suit against U.S. Steel.

The speculative side of the 1907 financial panic caused Americans to reassess Wall Street and spurred Populists and Progressives across the United States to turn to political action. In 1911, Kansas was the first state to pass a “blue-sky law” creating a state commission that determined which securities could be sold or traded within the state. Twenty-five states soon followed Kansas’s lead in an attempt to prevent speculative activity in securities, the root cause of the 1907 financial panic, according to many observers at the time.

In February, 1912, the Banking and Currency Committee of the U.S. House of Representatives began an investigation into the money trust that would become known as the Pujo Inquiry. Hearings began later in the year. The alleged members of the inner core of the money trust—Morgan, Baker, Stillman, and their respective financial institutions—were identified in large part because of their actions during the preceding panic. The highlight of the hearings was Morgan’s testimony, in which he explained the rescue team’s actions during the panic.

The most permanent legacy of the Panic of 1907 was the establishment of a decentralized central banking system, as proposed by the National Monetary Commission. The commission’s proposal was eventually adopted, although with many amendments, in the Federal Reserve Act of 1913. As the governor of the powerful Federal Reserve Bank of New York, Benjamin Strong, who investigated banks during the 1907 panic, became the dominant voice in the direction of the new system and remained so until his death in 1928.

Bibliography

Carosso, Vincent P. The Morgans: Private International Bankers, 1854-1913. Cambridge, Mass.: Harvard University Press, 1987. One of the most scholarly works available on J. P. Morgan’s investment banking activities. Contains a detailed and reliable account of Morgan’s activities during the 1907 financial panic.

Chernow, Ron. The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance. New York: Atlantic Monthly Press, 1990. A broad and accessible account of the Morgan dynasty, from the creation of the investment bank until 1990. Devotes one short chapter to the 1907 panic.

Cowing, Cedric. Populists, Plungers, and Progressives. Princeton, N.J.: Princeton University Press, 1965. A general intellectual history of the opposition to Morgan, Wall Street, and the increasing concentration of economic power. Provides an insightful guide to the Populist and Progressive critiques of American finance capitalism.

Kindleberger, Charles P. Manias, Panics, and Crashes: A History of Financial Crises. 4th ed. New York: John Wiley & Sons, 2000. A general survey of financial speculation and monetary crises from the eighteenth century to the late twentieth century. Also provides a general theory of the boom-and-bust nature of economic development.

Sobel, Robert. Panic on Wall Street: A History of America’s Financial Disasters. 1988. Reprint. New York: Beard Books, 1999. An accessible history of financial disasters in the United States, written in an entertaining style. Devotes one complete chapter to the 1907 financial panic.

Sprague, O. M. W. History of Crises Under the National Banking System. Washington, D.C.: Government Printing Office, 1910. This is the report of the National Monetary Commission, which was created as a direct result of the 1907 panic. Remains the most detailed account and analysis of the panic. Available in many university libraries.

Strouse, Jean. Morgan: American Financier. New York: Random House, 1999. Comprehensive biography of Morgan offers insights into the culture, political struggles, and social conflicts of the Gilded Age. Explains in easy-to-understand language the financial controversies of Morgan’s time. Includes photographs.

White, Eugene Nelson. The Regulation and Reform of the American Banking System, 1900-1929. Princeton, N.J.: Princeton University Press, 1983. Deals with the 1907 financial panic as a backdrop to the issue of banking reform in the United States. Contains a wealth of information on the American banking system before passage of the Federal Reserve Act in 1913.