Concerned investors gathered outside of the New York Stock Exchange during the panic of 1907.
Soerfm; CC-BY-SA-3.0 via Wikimedia Commons; Canva
What Was the Panic of 1907?
Over three weeks in October, 1907, the New York Stock Exchange witnessed a sharp, 50% decline that wreaked havoc throughout America’s banking system, second only in severity to the Great Crash of 1929. Wealthy, self-interested financiers would personally bail out the markets—and grow more even powerful in the process. Eventually, the crisis would lead to sweeping reforms of the financial system as well as the formation of the United States’ first central bank, the Federal Reserve.
What Caused the Panic of 1907?
The panic of 1907 was also known as the Knickerbocker Crisis, after the Knickerbocker Trust, one of the largest banks in New York. Stockbrokers who engaged in speculation had manipulated the price of shares of the United Copper Company in an attempt to corner the copper market; in effect, the opposite occurred, and those banks that funded the risky scheme experienced staggering losses.
The Knickerbocker Trust declared bankruptcy on October 22, 1907, sparking a contagion that would spread throughout the financial system, since many of Wall Street’s transactions had been financed through complex debt schemes. Trusts had provided uncollateralized loans to stockbrokers, which were used as collateral for call loans that would be securitized by commercial banks. The profits were then used to pay back the initial loan to the trust—although this scheme worked only as long as the market was trending higher, and profits were being made from the securitized loans.
While it was against the law for a nationally chartered bank to make these risky, uncollateralized loans, so much of the speculation on Wall Street would grow to depend on them. Therefore, trusts had provided an enormous value—as well as critical liquidity—to the markets, and their collapse was like a set of dominoes falling.
After the Knickerbocker Trust failed, panicked regional banks attempted to withdraw their funds from the New York trusts, but since these trusts had an extremely low cash-to-deposit ratio (sometimes as little as 5%), they quickly discovered there was no money left. The contagion spread throughout the country, and many state and local banks became insolvent as a result.
Would the government step in and save the day? The U.S. Independent Treasury system, which was in charge of the country’s monetary supply, tried but unfortunately was unable to inject sufficient liquidity back into the markets, and the crisis deepened. By November 1907, the Tennessee Coal, Iron and Railroad Company, one of the country’s biggest steel manufacturers as well as one of the first components of the Dow Jones Industrial Average, threatened to fail because its shares had been used as collateral during the United Copper Company speculation.
How Was the Panic of 1907 Resolved?
Known as the Gilded Age, the early 1900s were a time of monopoly and expansion, fed by the red-hot railroad and coal mining industries as well as the advent of steel. Technological advancements led to astounding gains in production and output, spurring a wave of immigration from Europe. New factories and machine shops seemed to spring up on a daily basis.
The nation’s wealth, along with its power, was in the hands of a few individuals, like Standard Oil’s John D. Rockefeller—the world’s first billionaire—railroad tycoon Cornelius Vanderbilt, and steel titan Andrew Carnegie.
While these men were often referred to as “robber barons” for exploiting the working class to their benefit, they also believed they had an obligation to “pay back” the society that fomented their riches through acts of philanthropy. This came to the fore during the panic of 1907 as these wealthy individuals literally stemmed the bleeding from their own wallets.
On October 19, 1907, financier J.P. Morgan hosted an all-night meeting in the library of his mansion with the United States Treasury Secretary, George Cortelyou, as well as the city’s biggest banking executives. They examined the balance sheets of the Knickerbocker Trust as well as several other companies in peril. The next day, the U.S. government promised $25 million to shore up the New York banking system while John D. Rockefeller pledged another $10 million of his personal wealth. Morgan also persuaded the banking presidents to commit another $23 million, thus narrowly averting the crisis.
Around the same time, Morgan helped Andrew Carnegie launch a bid for U.S. Steel to take over imperiled rival Tennessee Coal. Their timing couldn’t have been more perfect. President Theodore Roosevelt granted Carnegie antitrust immunity, making U.S. Steel the largest conglomerate of its time, worth an astounding $45.6 billion in today’s dollars.
Which Reforms Came About as a Result of the Panic of 1907?
The Panic of 1907 spurred greater oversight of the financial markets and would lead to the 1913 Federal Reserve Act, which established the Federal Reserve system as we know it. The Federal Reserve is in charge of managing the country’s monetary policies, regulating financial institutions and ensuring the stability of the financial markets. It is made up of a Board of Governors, 12 Federal Reserve Banks, and the Federal Open Market Committee (FOMC).
Among the reforms that were instituted post-crisis was the mandate that all banks keep a percentage of deposits on-hand as reserves. These are known as federal funds. The Federal Reserve sets a target rate of interest that banks can lend these funds at—this is known as the fed funds rate.
How was the Panic of 1907 Similar to the Financial Crisis of 2007–2008?
Is greed really good? So many parallels can be made between the Panic of 1907 and the Financial Crisis of 2007-2008. During both, speculation ran rampant. Asset bubbles formed from overleveraged and toxic debt: In 1907 the vehicle was equity speculation, while in 2007 it was subprime mortgages.
Both crises were financed through “shadow” banking systems, like trusts (1907) and investment banks (2007), which received little, if any, oversight. Both bubbles burst with catastrophic consequences, and both times, the U.S. government needed to step in with some assistance before the contagion took down the entire economy, although it was wealthy individuals that ultimately rescued the banks during the panic of 1907.
And both times, sweeping reforms were enacted in response to the crises: The Federal Reserve Act of 1913 was the effect of the Panic of 1907 while the Dodd-Frank Reform of 2010 was signed into law after the Financial Crisis. After all, like the saying goes, learning history can help us avoid repeating our mistakes.
