• Bruce Boyce

The Panic of 1907

Updated: 15 hours ago

Outside the stock exchange, October 1907

"From all over the city came messengers with leather satchels and suit cases for money. Porters and watchmen in the institution said they had never seen such withdrawals of gold and currency."

New York Times, Oct 24, 1907

Two earthquakes. One real. One in the realm of finance. Seemingly unrelated, both would play a role in the economic crisis of 1907. A crisis that would have long-lasting consequences for the monetary policy of the United States.

In the early hours of April 18, 1906, an estimated 8.0 earthquake struck the city of San Francisco and surrounding areas in northern California. The quake remains one of the worst natural disasters in U.S. history.

Aftermath of San Francisco Earthquake, 1906

In its aftermath, more than the quake itself, fires inflicted significant amounts of damage to the city. A majority of the fire insurance policies held in the city were underwritten by British companies. In the following months, even as relief money began to flow to California, insurers started paying off claims. Many of the British insurers, attempting to limit their liability, argued that it was hard to prove that fire was the cause of damage and not as a result of the earthquake itself. In the end, the companies were forced to pay out millions of dollars to policyholders. The backing for these payments came in the form of gold, and Great Britain exported a large amount of gold to the United States. This was a time when currency values were tied to the availability and price of gold. Their own gold supply now lessened, the British feared a devaluing of the pound-sterling versus the US dollar. In response, the Bank of England, the British central bank, raised the discount rate, essentially the rate charged to other banks. This tightened available credit and the money supply. On top of this, other British policies targeted American bonds and securities. When these became due, they were sold and money flowed from the United States to England and Europe. Before long, Great Britain had reversed its position from gold exporter to gold importer. In America, there was an economic contraction, and by early 1907, the United States drifted into a recession. In the Autumn, farmers in the western sections of the United States, coming off a successful harvest and shipping their crops east, increased the demand for currency and credit. The economy was showing signs of a crisis of liquidity and its effects would set the stage for a monetary aftershock.

Ever since there's been a stock market, there have been those who have sought to manipulate it to their advantage. In this case, it was an attempt to corner the market on stocks of United Copper Company. United Copper was owned by F. Augustus Heinze, considered one of the "Copper Kings" of Montana. Heinze had moved to New York City in 1906, and he forged a close relationship with Charles W. Morse. Morse, with the help of Tammany Hall corruption, had gained a monopoly of the city's ice business. He and Heinze had higher ambitions in New York's financial world.

Augustus's brother, Otto, devised the scheme to manipulate the stock of United Copper knowing that the Heinze family owned a majority of the company. He believed that a number of the Heinze's shares had been borrowed and then sold short by speculators. These speculators were betting on the price of the stock to drop. Otto proposed what is called a short squeeze. The Heinzes would aggressively purchase any outstanding shares of United Copper. This in turn would drive up the price of the stock. The short sellers, unable to find shares, would go to the Heinzes' who would then name their price. To finance this scheme, the men turned to Charles Barney, head of Knickerbocker Trust Company, New York's third-largest trust. Morse warned Otto that he would need more money than Barney had in order to successfully pull off the short squeeze. Barney refused, but Otto Heinze went ahead with his plans.

Trading on the curb, 1907

On October 14, 1907, he began purchasing up shares of United Copper which pushed the price up to $60 a share from $32. The next day, October 15th, he called the short sellers to return the borrowed stock. Otto miscalculated. The short sellers were able to get shares from sources other than the Heinze family. The price of United Copper shares plummeted. By Wednesday, October 16th, the share price was $10. The stock was being traded outside the New York Stock Exchange literally "on the curb". The Wall Street Journal reported: "Never has there been such wild scenes on the Curb, so say the oldest veterans of the outside market".

Otto Heinze was ruined. His failure meant he could not meet his financial obligations, and it forced his brokerage firm, Gross & Kleeberg, into bankruptcy. Meanwhile, the State Savings Bank of Butte Montana, owned by F. Augustus Heinze, had held United Copper stock as backing for much of its lending. On the collapse of the stock, the bank immediately declared insolvency. The state bank was also a correspondent bank of the Mercantile National Bank in New York, another bank headed by Heinze. Given his association with the attempted corner and the failed state bank, the board of the Mercantile National Bank forced Heinze to resign. By then, though, the news of the stock collapse had spread. Depositors rushed to withdraw money. This also induced a run on banks affiliated with Charles W. Morse.

Since the demise of the Second Bank of the United States in the 1830s, the U.S. had no central bank. In New York, a consortium of banks had formed the New York Clearing House which acted as a lender of last resort. As a result of the run, the New York Clearing House examined the books of its member banks, including the Mercantile National Bank, and declared them all solvent and able to meet their obligations. This temporarily calmed the panic, and Heinze and Morse were forced to resign from all the banks they were associated with. Trust companies, on the other hand, were not members of the clearinghouse. The New York Clearing House nor any other financial institution would not back the Knickerbocker Trust Company which now faced their own problems. Charles Barney was asked to resign, but on October 22, Knickerbocker suffered a bank run. The New York Times reported, "as fast as a depositor went out of the place ten people and more came asking for their money [and the police] were asked to send some men to keep order." Knickerbocker suspended operations, and other banks and trusts began halting lending. Within a few days, the panic would lead to several failures of financial institutions.

J.P. Morgan

Upon seeing the failure of the Knickerbocker Trust cascade to healthy banking firms, the leading American financier, J.P. Morgan was called in to quell the panic. Morgan met with leading bankers and the U.S. Secretary of the Treasury. They were able to infuse enough of their own cash to the struggling New York banks to shore up the bank deposits. One of the largest was the Trust Company of America. Because of Morgan's efforts, the company was able to sustain a massive run and pay depositors. This became symbolic in returning confidence to the financial system.

Yet despite their best efforts, Morgan, the U.S. government, and the other bankers could not continue to pool their funds. The banks in New York stopped the short term lending that provided money for daily stock trades. The prices of stock fell dramatically. It took the immense status of J.P. Morgan to keep the stock exchange from closing early on October 24th. Eventually, calm was restored by November 2 in New York, but the crisis would send aftershocks through an already weakened economy. The recession that grew from the money crunch in the aftermath of the San Francisco earthquake continued until June 1908. Real GDP (gross domestic product) fell by nearly 10% (twice the recession of 2008-09). Industrial production dropped by 11%, the greatest to that date, and the country saw the second largest number of bankruptcies, also a record for the time period. Unemployment rose to 8%.

Two issues became apparent. The banks did not have sufficient reserves to cover deposits. At least some of the banks had the clearinghouses to fall back on, but the trust companies acted outside the clearinghouse consortiums. Like Knickerbocker Trust, this meant they were more likely to fail. (Many economists have pointed out the similarities in the causes of the 2008-2009 recession and the crisis of 1907.) All of this renewed the call for monetary and banking reforms. In the wake of the recession and the panic, people began to realize they could not continually rely on men like J.P. Morgan to bail out the American financial sector. New support for a central bank grew. Senator Nelson Aldrich, a leading advocate for bank reform, spearheaded the reform efforts in Congress. In the spring of 1908, Congress passed the Aldrich-Vreeland Act. The act created the National Monetary Commission. The bipartisan commission was tasked with evaluating reform proposals and making any recommendations to Congress. The most significant of these recommendations was the creation of a national bank.

The Federal Reserve would be created by the Federal Reserve Act of 1913. From that point forward, the Federal Reserve has served as the United States central bank, the lender of last resort, and overseer of monetary policy in America.


More on the Panic of 1907:

The Panic of 1907: Lessons Learned from the Markets Perfect Storm: Robert Brunner and Sean Carr

The Hour of Fate: Theodore Roosevelt, J.P. Morgan, and the Battle to Transform American Capitalism: Susan Berfield

Real Shock, Monetary Aftershock: The San Francisco Earthquake and the Panic of 1907: Kerry Odell and Marc Weidenmier (National Bureau of Economic Research)


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