Panic of 1907 - Business in United States of America
The Event: Stock market crash that accompanied the failure of many New York banks but was mitigated by massive investments made by J.P. Morgan.
Date: October, 1907
Place: New York, New York
Significance: The Panic of 1907 led to the creation of the Federal Reserve system.
Beginning in 1896, the U.S. economy entered a sustained period of prosperous activity, especially on the stock market. The market was the means whereby a major consolidation of U.S. businesses was carried out, largely through the efforts of men of great wealth, such as John D. Rockefeller, Edward H. Harriman, Andrew Carnegie, and, above all, J. P. Morgan. These business consolidations were driven by a widespread conviction that the gyrations of the business world should be suppressed through monopoly control of important parts of the economy. Rockefeller’s effective control of the oil market was the model for the consolidations.
One consequence of this period of consolidation was the establishment of numerous “trusts,” that is, investment houses that traded in the securities of many businesses. In 1906, there were some one thousands of these trusts. Although they resembled banks, trusts were not required to hold a certain percentage of the money they managed as “reserves,” that is, as cash or its ready equivalent. In 1906, New York State introduced a requirement that trusts keep 15 percent of their total assets in reserves, though only one-third of this amount (5 percent of total assets) had to be in cash. This requirement was still being implemented in 1907, so many trusts were still almost entirely dependent on the marketability of their assets when the panic broke.
Another major factor in the Panic of 1907 was an event that could not have been foreseen: the earthquake and subsequent fire that struck San Francisco in April of 1906. The almost total destruction of large parts of the city put many insurance companies at risk, and in 1906-1907, Wall Street experienced a substantial sell-off of insurance company stocks. The value of insurance-sector stocks dropped by 15 to 30 percent, and railroad stocks dropped by more than 15 percent. As a result of these market pullbacks, there was insufficient capital available to finance the 1907 crop year.
The immediate trigger of the Panic of 1907 was the attempt of a couple of speculators to corner the market in copper. As they proceeded to buy up shares of companies with copper holdings in Montana, they discovered that the market was dealing in more shares than they had calculated, meaning that the shares had been used as collateral for other purchases. The two leading speculators had used funds they had borrowed from the Knickerbocker Trust Company to pay for the copper company shares they were amassing. As soon as it became known that the Knickerbocker company had provided the funding for their speculation, the company became the object of a bank run.
The financial unrest associated with the Panic of 1907 began in earnest on October 21 and extended through the next two weeks. The Knickerbocker Trust Company lacked the cash to pay all the depositors who lined up to withdraw their funds. On October 22, the trust suspended payments to depositors. On the same day, the National Bank of Commerce let it be known that it would no longer accept checks from the Knickerbocker Trust; lines then formed around other banks, as depositors tried to withdraw their deposits. The National Bank of Commerce was sometimes known as J. P. Morgan’s bank, and Morgan became the leader of a group of financiers trying to prevent the bank runs from spreading. At the same time, banks outside New York City that had deposits in New York City banks joined individual depositors and began trying to withdraw their deposits.
The market problems of 1907 are depicted in this political cartoon showing “common honesty” erupting from the volcano and people fleeing with “secret rate schedules,” “rebates,” “stocks,” and “frenzied accounts.” (Library of Congress)
Morgan and a coterie of other financiers of the leading New York banks began a series of meetings, to which the secretary of the Treasury was invited. By Thursday, not only Morgan but also the U.S. Treasury had begun to make loans to all the major New York banks to ensure that their cash supplies would be sufficient to meet all demands. When these demands increased, threatening to exceed supply, Morgan pressured the other leading financiers to advance additional funds to cover the banks’ needs. By the weekend, Morgan had learned that a shipment of gold was on its way to New York from London. The New York clearinghouse banks agreed, on being pressured by Morgan, to issue clearinghouse certificates that could temporarily supplement their cash supplies.
On Monday, October 27, Morgan learned that the City of New York would be unable to meet its payroll obligations. He agreed to buy revenue bonds from the city that would replenish its cash supply, enabling it to pay its employees. By this time, the panic was spreading to Wall Street, and a number of well-known firms such as Westinghouse Electric announced that they would be forced to declare bankruptcy.
Recovery and Result
By the beginning of November, the turmoil began to subside. In the end, only six banks failed, along with a number of companies listed on the New York Stock Exchange. As those directly involved began to reflect on the panic, however, it became clear to them that the country needed a central bank or its equivalent. Congress, under the leadership of President Theodore Roosevelt, began to investigate the panic and its causes. By 1912, government leaders had come to the conclusion that a central reserve was needed. On December 23, 1913, they passed the Federal Reserve Act.
Further Reading Allen, Frederick Lewis. The Great Pierpont Morgan. New York: Harper & Row, 1965. Popular biography that provides many of the details of how Morgan engineered the rescue of the New York banks in 1907.
Bruner, Robert F., and Sean D. Carr. The Panic of 1907: Lessons Learned from the Market’s Perfect Storm. Hoboken, N.J.: John Wiley & Sons, 2007. Well researched account of the events of the Panic of 1907.
Cochran, Thomas C. The Age of Enterprise: A Social History of Industrial America. New York: Macmillan, 1960. Essential background for the events of 1907 by a leading business historian.
Kindleberger, Charles, and Robert Aliber. Manias, Panics, and Crashes: A History of Financial Crises. 5th ed. Hoboken, N.J.: John Wiley & Sons, 2005. Economic analysis of the factors that brought about the panics of the nineteenth and early twentieth centuries.
Rockoff, Hugh. “Banking and Finance, 1789-1914.” In The Cambridge Economic History of the United States, edited by Stanley Engerman and Robert Gallman. Vol. 2. New York: Cambridge University Press, 2000. Excellent survey of U.S. economic history during the nineteenth century.
See also: bank failures; banking; Business cycles; Panic of 1819; Panic of 1837; Panic of 1857; Panic of 1873; Panic of 1893.