Download The Panic of 1907 and the Responses of the United States Really

ThePanicof1907andtheResponsesoftheUnitedStates
ReallyGoodResearcher&Writer
Econ40413
11December2012
Abstract:ThePanicof1907wasamajorfinancialcrisisinUnitedStates
historybothintermsoftheeventsthatcauseditandthepoliciesthe
UnitedStatesadoptedinresponsetoitsoccurrence.ThePanicof1907
happenedatatimewhentheUSeconomywasalreadyinrecession.Itwas
officiallyconsideredapanicwhentheNewYorkStockExchangefellnearly
fiftypercentinaday.TheeffectsofthiscrashinNewYorkquicklyspread
throughouttheentirecountry.ThePanicof1907piquedmyinterest
becauseIsawanopportunitytotakethetopicindifferentdirections.One
focusofthispaperwillbetoexaminethecausesofthePanicof1907,
includingthedecisionsbankersmadethatledtoit.Additionally,thiswasa
majortimeperiodintheevolutionoftheUnitedStatesmonetarysystem,
whichallowsonetoalsoexploretheresultsofthePanic,primarilywhat
thecountrydidinresponsetopreventanothersuchpanicfromoccurring.
ThePanicof1907wasuniqueinthesenseoftheriseofindividualactions,
whichhelpedsavethecountryfrombiggerproblems,specificallyJ.P.
Morgan,whoiswidelyregardedasoneofthemostinfluentialfinanciers
ever.CoveringthePanicof1907willallowmetoexplorethemistakes
peoplemadeleadinguptoit,whatspecificallycausedit,andhowthe
countrypulleditselfoutofit.Additionally,economistsalsofindsimilarities
amongthefinancialcrisesthathaveoccurredthroughouthistory,which
providesanotheropportunitytopotentiallylookatsimilaritiesbetween
thisoneandevenourmostrecentfinancialcrisisin2008.
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ThePanicof1907andtheResponsesoftheUnitedStates
ReallyGoodResearcher&Writer
Abstract:ThePanicof1907wasamajorfinancialcrisisinUnitedStates
historyintermsofboththeeventsthatcauseditandthepoliciesadopted
bytheUnitedStatesinresponsetoitsoccurrence.ThePanicof1907came
duringatimeinwhichtheUnitedStateseconomywasalreadyin
recession.ItofficiallybecameapanicwhentheNewYorkStockExchange
fellnearlyfiftypercentinaday.TheeffectsofthiscrashinNewYork
quicklyspreadthroughouttheentirecountry.ThePanicof1907becameof
interesttomeasIsawanopportunitytotakethetopicindifferent
directions.Onefocusofthispaperwillbetoexaminethecausesofthe
Panicof1907,andthedecisionspeople,namelybankers,madethatledto
it.Additionally,thiswasamajortimeperiodintheevolutionoftheUnited
Statesmonetarysystem,whichallowsonetoalsoexploretheresultsofthe
Panic,primarilywhatthecountrydidinresponsetopreventanothersuch
panicfromoccurring.ThePanicof1907wasuniqueinthesenseoftherise
ofindividualactions,whichhelpedsavethecountryfrombiggerproblems,
specificallyJ.P.Morgan,whoiswidelyregardedasoneofthemost
influentialfinanciersever.CoveringthePanicof1907willallowmeto
explorethemistakespeoplemadeleadinguptoit,whatspecificallycaused
it,andhowthecountrypulleditselfoutofit.Additionally,economistsalso
findsimilaritiesamongthefinancialcrisesthathaveoccurredthroughout
history,whichprovidesanotheropportunitytopotentiallylookat
similaritiesbetweenthisoneandevenourmostrecentfinancialcrisisin
2008.
Introduction
ReallyGoodResearcher&Writer3
ThePanicof1907,alsocommonlyknownastheBankers’Panic,provedtobe
apivotaltimeinthehistoryoftheUnitedStatesmonetarysystem.Themistakesand
failuresthatledtoitwereanalyzedandmajorreformssweptthenation.Although
thecountrywasapprehensiveaboutestablishingacentralbankingsystemfollowing
thenation’sfirsttwoattemptsatafederalbank,bankerswerefreetousemoney
andhadlimitedrestrictionsonthingssuchasrequiredreserves.Previouspanicsin
theUS,includingthePanicof1837,alsoledmanycitizensofthecountrytobecome
skepticaloflargebanking.Additionally,thiswasatimewhenmonopolies
controlledmuchofindustryintheUSandthesemonopoliesplayedapivotalrolein
thepanic,aswellastheoutcomes.Itcanbearguedthat,inadditiontothebanks,
monopoliesandpowerfulindividualswerethemostcriticalplayersinthePanicof
1907.
ThePanicof1907wasmuchmorethanamonetarypanicthatspannedone
year.Whenlookingatthecrisis,onemustconsidernumerousfactors,includingthe
eventsimmediatelyprecedingthepanic,thecausesofthedisaster,andthe
influentialpeopleinvolvedandthedecisionstheymade.Onemustalsoexaminethe
actionstakenbypeopleandinstitutionstoresolvethepanicandsettleanation,as
wellasthepoliciesthatweredevelopedandadoptedinresponsetothePanicof
1907.ItisalsointerestingtocomparethePanicof1907tootherfinancialcrisesin
history,aseconomistsrealizethistypeofproblemisnothingnew.Economists
generallyagreethattherearesimilaritiesbetweenmosthistoricalfinancialcrises,
regardlessofwhentheytakeplace.Eventhoughthemostrecentfinancialcrisisand
thePanicof1907occurredslightlymorethanonehundredyearsapart,itismore
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thanlikelythattheyhaveatleastonecharacteristicincommon.Themostcritical
topicstoanalyzeregardingthePanicof1907areitscauses,thereactionsofthe
nationduringthepanic,andthechangesthatresultedfromournation’sresponses.
19thCenturyUnitedStatesBanking
The19thcenturywasanunstabletimeinUnitedStatesbanking.Thiswasa
centurythatsawtheUSsufferthroughmultiplefinancialcrises.Atthistimethere
werestillmanypeopleintheUnitedStatesthatwerewaryofestablishingalarge,
centralizedbankingsystemintheUS,amindsetthatwentbacktotheearliestroots
ofthenation.ThisleftthetaskofhandlingthemajorityofbankingtothecityofNew
York.Inthe1800s,NewYorkwastheonlycentralreservecityintheentirecountry
(Wicker29).Thishelpedtoalleviatetheeffectsofrecessionsinthe1800sonthe
stateofNewYork,butthesefinancialproblemshadmuchgreaterimpactonvarious
otherstatesacrossthecountry.Duringtheearlyrecessionsinthe19thcentury,
numerousbanksaroundthecountryfailed,dueinlargeparttothefactthatthey
werenotresponsiblewiththeirliquidassets(Wicker21).NewYork,howeverwas
centralizedandpowerfulinbanking,andthereforeonlyfeltamuchlessereffectof
thesepanicscomparedtootherstatessuchasOhio,Indiana,Illinois,Massachusetts,
NewJerseyandConnecticut.Itisestimatedthattheseotherstatessufferedabout
twiceasmucheconomiccontractionasNewYorkdidduringthesepanics(Wicker
29).Withsomuchofthenation’sbankingfocusedinNewYork,theNewYork
ClearingHousewasessentiallythelenderoflastresortfortheUS.Thedecisionsof
theNewYorkClearingHousehadmajorimpactsontheeffectsoffinancialcrisesin
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the1800s.ThePanicof1907wouldultimatelybethelastdisasteritfaced,asreform
promptedachangeinthelenderoflastresort.
ThePre‐PanicYears
UnderstandingthecausesofthePanicof1907iscrucialtodevelopinga
foundationofknowledgethatallowsonetounderstandtheimpactsandresultsof
thefinancialcrisis.ItisimportanttorealizethatthePanicof1907wasnotasudden
occurrenceduetoproblemswithinthebankingsystem.Instead,itresultedfroma
buildupofpoordecision‐making,anditwasessentiallyagamblethatwentthe
wrongway.WhilebankscontributetothecausesofthePanicof1907,othermajor
playersinthecreationofthepanicweretrustcompanies.Manytrustcompanies
existedinNewYorkatthetimeandoperatedasaplaceforwealthierpeopleto
investtheirmoney.FollowingthebankingpanicthattheUnitedStatessufferedin
1893,theNewYorkClearingHousewasstillthemajorlendertobanksas“no
attempthadbeenmadeintheinterim(1893‐1907)todeviseastrategyfor
preventingbankingpanics”(Wicker83).Failuretoactonthesepreviouspanicsin
the1800sledtothecountry’scontinuedinabilitytopreventandsolveanewcrisis,
particularlytheonethatwouldhappenin1907.AccordingtoRichardT.McCulleyin
hisbookBanksandPoliticsDuringtheProgressiveEra:TheOriginsoftheFederal
ReserveSystem,1897‐1913,theUnitedStateswasexperiencingatimeofexpanding
businessthatwascreatingastockmarketboomanddrivingupinterestrates
(McCulley121).Thiswasbeneficialforthenation’seconomy,butitbegantoputa
lotofpressureonbankstomeetcashdemandsofinvestors.Inaddition,banksdid
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notkeepanadequatesupplyofliquidreservesonhand,becauseregulationswere
looseanddidnotforcebankstodoso(McCulley120).Thisfactoralsocontributed
tothestrainonthebanks.TheUnitedStatesbegantoseewarningsignsthat
indicatedpotentialpanicinthemonetarysystem,andsomepeopledidinfacttryto
actbeforethecrisishit.LeslieM.Shaw,wastheUnitedStatesSecretaryofthe
Treasuryatthetime,pushedCongresstoconvertthetreasuryintoacentralbankin
ordertogiveitmorecontrolovercontractionsandexpansionsinthemoneysupply
andtoestablishitasacentralreservefund(McCulley119).Unfortunately,the
FederalGovernmentwasunabletoreachanagreementonhowtoproceedand
Shaw’sideasnevercametofruition.
Anotherkeyaspectinthepre‐paniceraistherelationshipbetweenthe
UnitedStatesbanksandbanksaroundtheworld,particularlythoseinEurope.
Duringtheearly1900s,theUShadbeenborrowinglargeamountsofcapitalfrom
Europeanbanks,primarilybanksinLondonandItaly.TheUnitedStatesimported
goldfromLondonmostlyonaccommodationpaper,whichallowedcompaniesand
bankstoborrowlargesumsofcapitalintheformofshort‐termloansthateffectively
becamelong‐termloansbecausetheborrowercouldcontinuetorollthemoveras
theymaturedyearafteryear(Kindleberger77).Thisformofborrowingwas
developedintheearly19thcenturyinresponsetothesuspensionofthegold
standard,eventhoughgoldwasstillapopularlytradedcommodity,especially
betweenEuropeandtheUnitedStates.BorrowingfromtheBankofEnglandwasnot
themajorissuefacingtheUnitedStates,butratherthestructuraldifferences
betweenthetwobanksposedaproblem.Londonwasacentralizedbankingsystem,
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whichmeantthattheLondonbankshadcontroloverthediscountrateusedto
adjustitsinterestrates.Infact,thebanksinLondonusedthispowertoavoidthe
financialpanicof1873thathitAustriaandGermany,aswellastheUnitedStates
(Kindleberger88).NewYork,ontheotherhand,wasnotacentralbankand
thereforecouldnotcontrolthis.ThismeantthatifLondonmadeachange,the
UnitedStateshadnomeanstorespondinordertoavertacrisis.Forinstance,ifa
problemunexpectedlyaroseinEnglandandtheyneededtoraisetheirinterest
rates,theUnitedStateswouldowemoremoneyontheirdebts.However,theUS
wouldhavenointernalwayofraisingthiscapital,andwouldfaceapotential
disaster.Thisexampledemonstratestheneedforalenderoflastresort.Infact,this
isoneofthemajorproblemstheUnitedStatesencounteredonthewaytothe
financialpanic.
IntheirbooktitledManias,Panics,andCrashes:AHistoryofFinancialCrises,
CharlesP.KindlebergerandRobertAdlerdevoteasectiontoclearlydefiningacrash
andapanic,bothofwhichcanplayapartinafinancialcrisis.Theauthorssaythata
crashisa“collapseofthepricesofassets,orperhapsthefailureofanimportantfirm
orbank.Apanic,‘asuddenfrightwithoutcause’mayoccurinassetmarketsor
involvearushfromlessliquidsecuritiestomoneyofgovernmentsecurities”
(Kindleberger110).IntheUnitedStates,thepanicwassetoffbyanaturaldisaster
in1906.Anearthquakeregistering8.3ontheRichterscalestruckthecityofSan
FranciscoinAprilof1906.ThiscreatedpanicintheUSmonetarysystembecause
SanFranciscowasthefinancialcenteroftheWestatthattime(Odell1010).Afire
accompaniedtheSanFranciscoearthquake,leavingmuchofthecityinruins.The
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UnitedStatesnowdemandedhugeinflowsofcapitaltorepairthedamages,which
increasedthefeelingsofpanic.Withoutacentralbankingsystem,decisionsofother
countriesmagnifiedtheimpactsofthedisasterontheUnitedStates.Accordingto
KerryA.OdellandMarcD.Weidenmierintheirreporttitled“RealShock,Monetary
Aftershock:The1906SanFranciscoEarthquakeandthePanicof1907,”thedamage
tothecityofSanFranciscoexceededonepercentofthenation’sGrossNational
Product.Infact,itisestimatedthatthedamagewassomewherebetween350
millionand500milliondollars,bringingthetotaldamageintermsofGrossNational
Producttosomewherebetween1.3and1.8percent(Odell1003).TheUnitedStates
broughtinlargeamountsofcapitalinanattempttoproviderelief,including$30
millionfromEnglandand$20millionfromGermany,France,andtheNetherlands
(Bruner14).Additionally,Englandfacedanothermajorproblem.Itsinsurancefirms
comprisedabouthalfofSanFrancisco’sfireinsurancepolicies,whichleftthenation
withabout50milliondollarsinlosses(Bruner14).Inresponsetothis,England
raiseditsratesongoldfrom3.5percentto4percent,andthenagainfrom4percent
to6percentinanefforttokeepothernationsfromdrainingitsreserveofgold
(Bruner15).AslargeamountsofcapitalflowedoutofNewYork,theNewYork
StockExchangefeltasignificantimpactfromtheearthquake.Itisestimatedthe
stockmarketfellabout12.5percenttotalfollowingtheearthquake,whichisequal
toroughlyaonebilliondollardeclineinthevalueofthemarket(Bruner14).These
estimatesareevidencethatpanicbegantoariseintheUnitedStatesin1906dueto
decreasingsuppliesofdomesticcapitalandtheincreasingcostofforeigncapital,
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whichresultedfromanaturaldisaster.Panicfromthenaturaldisaster,combined
withacrashinthemarket,setthestagefora1907financialcrisis.
ThePanicof1907
Theitemsdiscussedintheprevioussectionarethefoundationofthe
financialcrisis.WhileeconomistsdoagreethattheSanFranciscoearthquake
contributedtothePanicof1907,themaincauseiswidelyattributedtoadifferent
setofevents.Again,thecommonthemeisthelackofacentralbankingsysteminthe
UnitedStates.Withnolenderoflastresort,therewasno“reliablewaytoexpandthe
moneysupplyintheUnitedStates”(Moen).Theeconomywascontracting,thestock
marketwasfalling,andthelackofavailablecreditwasdrivingupinterestrates.
Pricesofcommoditiesfelltwenty‐onepercent,bankruptciesclimbedbynearlyfifty
percent,productionfellroughly11percent,andtheunemploymentratejumped
from2.8to8percent(Bruner142).However,theUShadnomeansofrespondingto
theseissues.
Themaintriggertotheentirepanic,however,waswhenamannamedF.
AugustusHeinzelookedtocornerthestockofamajorUnitedStatescopper
company:UnitedCopperCompany.Atthetime,afirmbythenameofAmalgated
CopperCompanycontrolledroughlyfiftypercentoftheU.S.coppermarketandwas
regardedasamonopoly(McCulley145).Duringthefirsthalfof1907,thecopper
markettookatumble,sotheAmalgatedCopperCompanysignificantlyreducedthe
amountitreleasedtothemarketinanefforttosustaintheprice.TheAmalgated
CopperCompanyinsteadstockpiledmostofitscopperwiththeUnitedMetals
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SellingCompany,asubsidiary(McCulley145).F.AugustusHeinzewasabusiness
competitortoAmalgated.HegainedcontrolofeightNewYorkbanksandusedfunds
fromeachoneinanattempttomakemoneyoffthecoppermarketthroughstock.
UnfortunatelyforHeinze,afterhepurchasedahugenumberofsharesofstockfrom
theUnitedCopperCompany,theUnitedMetalsSellingCompanyreleasedmillionsof
poundsofcopperintothemarket.Thisdrovedownthepriceofcopper,bringingthe
priceofthecopperstockdownwithit(McCulley145).Thisdropinthemarket
causedthosewhohadinvestedinthebanksthatHeinzecontrolledtolosefaith,and
manyquicklysoughttowithdrawtheirdeposits,leavingthesebanksshorton
capital.
Asthepanicbegan,thesurfacestillappearedcalmbecausemanyofthe
institutionsfacingpanicweretrustcompaniesandnotthebanksthemselves.Atthe
time,theNewYorkClearingHouserequiredbankstoholdatleasttwenty‐five
percentoftheirreservesincash.Thetrustcompanies,ontheotherhand,were
understateregulationsandthereforewerenotobligatedtofollowtheguidelinesset
bytheNewYorkClearingHouse.Theywerenotrequiredtokeepalloftheir
reservesincash;theywereallowedtohavethemsecuredininvestments(Bruner
67).Infact,ofthefifteenpercentrequiredreserverate,thesetrustcompaniesonly
hadtoholdone‐thirdincash(Bruner67).Thismeansthatthesetrustcompanies
werenotequippedtorespondatatimewhencashwouldbeindemand,andthisis
exactlythecaseinthePanicof1907.
Whiletheeightbanksfacedscrutinyforparticipatingintheattemptto
cornerthestockmarket,runsontrustcompaniesalsocontributedtothe
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developmentofthepanic.ItisbelievedthatC.F.Morse,whowasinchargeofthe
KnickerbockerTrustCompanylocatedinNewYork,wasinvolvedwithHeinzeinhis
attempttocornerthecoppermarket(Moen).Again,thetrustcompanieswerenot
directlyassociatedwiththeNewYorkClearingHouse.Duetothis,theNewYork
ClearingHousewasnotresponsibleforprovidinga“bailout”tothetrustcompanies.
DespitethefactthattheydidnothavingthebackingoftheClearingHouse,trust
companiesweremoreattractivetoinvestorsbecausetheybroughtmuchhigher
returns.Inaten‐yearperiodendingin1907trustcompaniessawtheirassetsgrow
244percenttoreachover1.3billiondollars,whilenationalbanksgrew97percent
andtheassetsinstatebanksinNewYorkgrewonly82percent(Bruner67).Many
companiesencounteredproblemsduringtheperiodfollowingtherunonthecopper
market.Investorsbecamesuspectofwhatwasgoingonsotheybegantorapidly
withdrawtheirfundsfrombanks,leavingfinancialinstitutionsevenmorestrapped
forcashatatimewhentheywerealreadystrained.Ultimately,theNewYork
ClearingHousedecidedtostopclearingchecksfortheKnickerbockerTrust
Company,whichleadtoitsdemise(McCulley146).AlthoughtheKnickerbocker
TrustCompanycouldnotbesaved,thenationlookedforotherresponsestothe
Panicof1907.
Responses:J.P.Morgan
ThinkingthattheNewYorkClearingHousewasactingtooslowlyand
outrightdisagreeingwithitsdecisiontostopclearingchecksfortheKnickerbocker
TrustCompany,amanbythenameofJ.P.Morgantooktheinitiativeinseekinga
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solutiontothepanic.J.P.Morgan,oneofthemostfamousprivatebankersand
financiersinUnitedStateshistory,wasseventyyearsoldatthetimeofthepanic
andarguablyinthestretchrunofhisbankingcareer.Morganrealizedthat
somethingneededtobedonequicklyandthattheNewYorkClearingHousewasnot
movingfastenoughwithitsdecisions.HealsobelievedthattheClearingHousewas
notoperatingonascalelargeenoughtosaveAmerica’sfinancialsystem.Morgan
assembledateamofprivateinvestorstoessentiallyspearheadtheshort‐term
response(onetotwoweeksfollowingthefirstrun)tothepanic.Theydecidedthat
itwastoolatetosavetheKnickerbockerTrustCompany,andtheyinsteadshifted
theirfocustowardaidingotherfinancialinstitutionsinanefforttopreventthem
fromsufferingthesamefate.Morgan’stopadvisersonthecommitteewereJames
StillmanfromNationalCityBankandGeorgeBakerfromFirstNationalBank
(Tallman7).Inadditiontothesethree,ateamofyoungfinanciersaidedinthe
processofanalyzingtheassetsandliabilitiesoffinancialfirmstodeterminewhat
neededtobedonetopreventarunontheircapital.OtherfirmsincludingtheTrust
CompanyofAmericaandLincolnTrustexperiencedrunsontheircapital.Infact,the
TrustCompanyofAmericapaidout47.5milliondollars(Tallman8).J.P.Morgan
personallypledged3milliondollarstotheTrustCompanyofAmericatoallowitto
remaininoperation.
FollowingthispersonalpledgefromMorgan,otherwealthyAmericansjoined
hisefforttosavetrustcompanies.JohnD.Rockefellerwasonesuchperson.Hegave
10milliondollarsofhisownmoneytobailoutvarioustrustcompanies(Tallman8).
Morgan’splansandactionsevengarneredthesupportoftheUnitedStatesTreasury.
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TheTreasury,underthedirectionofGeorgeCortelyou,gave37.6milliondollarsin
aidtonationalbanks,beforeitcouldnolongeraffordtogiveanymoreofitsassets
(Tallman8).
Thenextstopintheshort‐termrecoverywastofindawaytogetthestock
marketmovingupagain.ThistimeMorganandhisgroupgavetenmilliondollarsto
therescuecauseandtheireffortsbarelykeptthestockmarketopenfortherestof
theday(Tallman9).
ClearlyMorgan’sworkwasstillfarfromdone.Panicactuallycontinuedto
spreadallthewaytotheNewYorkgovernment,whichneededthirtymilliondollars
tofulfillitsshort‐termobligations.TheMayorofNewYork,GeorgeMcClellan,
turnedtoMorganforhelp.Tosolvetheissue,Morgan,alongwithStillmanand
Baker,wroteathirtymilliondollar,sixpercentbondtothecityofNewYork,again
puttingtheirownassetsonthelineavertfurthercrisis(Tallman10).Majortrust
companiescontinuedtohaveissuesafterthisanditwasMorganyetagainwho
convincedprivateinvestorstopooltogethertwenty‐fivemilliondollarstosave
thesefinancialinstitutions.Afteraboutthreeweeksoftheseoperations,panicbegan
tosubsidethroughoutNewYork,astrustcompanypresidentsfinallycametogether
toformasupportnetworkforcompaniesexperiencingruns.
TheworkofJ.P.MorganwassoincrediblycrucialtotheUnitedStates
recoveringfromthepanic.Injustthreeweeks,Morganwasabletoformplansthat
avertedmajordisaster.TheNewYorkClearingHousewasnotonlyactingslowly,
butalsofoolishlyinitsdecisionsnottohelptrustcompanies.ItwasMorganwho
recognizedthedangersoflettingtheselargecorporationsfailandwhatitmight
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possiblymeanforthefutureofthecountry.Bypledginglargesumsofhisown
money,hewasabletogainthesupportofotherpowerfulindividualsinAmericato
saveitsfinancialinstitutions.Hisworkwasextremelydiversified,asheimpacted
multiplesectorsoftheeconomy,usingtheskillsetthathelpedhimachievepersonal
success.Morganwasalreadyconsideredoneofthegreatestfinanciersofhistime,
buthisworkinthethreeweeksfollowingthefirstrunsontrustcompanies
cementedhislegacyasabankingherointheUnitedStates.Today,itis
acknowledgedthathesinglehandedlysavedthenationduringthispanic.
Hisworksolvedmanyofthecountry’sshortrunproblems.Tosolvethe
problemstheUSwouldfaceinthelongrun,includingavoidingasimilarfuturecrisis
requiredadifferentsetofsolutions.Manyofthesesolutionscameintheformof
newpolicy.
Responses:PoliciesandtheFederalReserve
J.P.Morgan’seffortswerecrucialtotheshort‐termsuccessoftheUnited
Statesandkeptfinancialinstitutionsafloat.However,manypeoplerealizedthat
long‐termchangeswereneededinordertoavoidanothercrisisinthefuture.Itwas
apparenttothecitizensofUnitedStatesthatacentralbankingsystemwasneeded.
Thelackofalenderoflastresortwasarecurringissueamongthepanicsofthelate
1800sandearly1900s,butacentralbankwouldactasalenderoflastresort.Atthe
timemanyAmericanswereskepticalofalarge,centralizedbank,astheyfearedthe
possibleeffectsofheavygovernmentinvolvementinthemonetarysystem.Itwas
decided,however,thatasystemofsmall,undiversifiedbankswasmoreproneto
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panicandcrisisthanacentralizedbankingsystem(Bruner161).TheUnitedStates
coulduseacentralizedbanktoactasshockabsorbertotheeconomyandtoprotect
thefinancialsystem.
NelsonW.Aldrichwasthefirsttobeginthemovementforacentralized
bankingsystem.In1908,CongresspassedtheAldrich‐VreelandAct(Bruner143).
Theactsetupafundofemergencycurrencytoprovidetobanksbasedonthe
reservestheyheld.TheNationalReserveAssociationwasappointedtomonitorand
distributethesefundsasneeded,anditwasthelargestholderofthenation’s
reserves(McCulley238).Unfortunately,Aldrich’splanwasneverfullyrealized,
becausepeoplefearedthatthebankingclasswouldobtainfullcontroloverthis
organization.Inhisarticle“BankingReformintheUnitedStates”thatappearedin
TheAmericanEconomicReview,E.W.Kemmerernotesthat,“thegreatobstacletothe
reformhasbeenthefearthattheNationalReserveAssociationwouldbecontrolled
andselfishlyexploitedbyfinancialinterests”(Kemmerer53).Thefearofalarge,
centralizedpowerstillinfluencedthethoughtsandactionsofmanypeople.Thefear
ofasinglegroupinsocietygaininganadvantagethroughtheuseofagovernment
systemseverelyslowedtheprogresstowardestablishingacentralizedbankinthe
UnitedStates.Everyattempttoestablishsuchaninstitution,includingthefirstand
secondbanksoftheUnitedStates,failedtobecomepermanentmainstaysinthe
country.
Additionally,Aldrichtriedtobeaspoliticallyneutralaspossibleinhis
approachtocraftinghisplan.Heaimedtokeeptheroleofgovernmentinhis
bankingsystemverylimited.Henearlywantedthegovernmenttobeanon‐existent
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factorintheNationalReserveAssociation.Unfortunately,thiswasalsoadownfallin
hisplan.ForthistobeasuccesshewouldneedthesupportoftheRepublicanparty
butit“ignoredtheplan,probablyinpart,becauseitwasthedesireoftheleadersto
keepthequestionofbankingreformoutofthepoliticalarena”(Kemmerer53).The
lasthopefortheAldrichActtobecomepermanentintheUnitedStatesfadedwith
the1910Congressionalelection,inwhichtheDemocraticpartytookamajorityof
theUnitedStatesCongress(Bruner146).TheDemocraticpartyadmittedtherewas
aneedforreforminthebankingsystem,butsimplydidnotagreewiththeplanlaid
outintheAldrichAct.However,peoplestillrecognizedtheneedforalenderoflast
resort.IntheyearsfollowingthefailureoftheAldrichAct,theUnitedStatespassed
arguablyoneofthemostimportantreformsinitshistory.
Knowingthatmajorfinancialreformswerenecessary,thenationlookedto
setupasystemtoprotecttheUScurrency.OnDecember22,1913,Congresspassed
theFederalReserveAct,whichservedas“anacttoprovidefortheestablishmentof
FederalReserveBanks,tofurnishanelasticcurrency,toaffordmeansof
rediscountingcommercialpaper,toestablishamoreeffectivesupervisionof
banking,andforotherpurposes”(Bruner146).Theactestablishedthreemaingoals
fortheFederalReserve.Thesewereasfollows:tomaximizeemploymentinthe
UnitedStates,tokeeppricesstable,andtocontrollong‐terminterestrates.The
creatorsoftheFederalReserveActdividedthenationintotwelvedistricts,each
withitsownregionalreservebank.Thisdivisionwasmeanttopreservethesense
thatthecentralizedbankingsystemhadlimitedpower.However,eachofthese
bankswouldhavethesamepowers,whichincludedtheabilitytoprintcurrency.
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Writingthisactwascomplicated.Thewritershadtobalancethe
divisionofpowerandresponsibilitiesbetweenpublicandprivateparties.This
balancewasnecessaryinordertopreventthegovernmentfromhavingtoomuch
influenceovertheFederalReserve.However,thewritersalsoneededtobesurethe
FederalReservefollowedtheguidelinesforreserverequirementsandsoon.One
provisionestablishedoftheFederalReserveBoard.Thisteamofpeoplerepresented
thepublic’sinterestswithregardtotheFederalReserve.Itwastheresponsibilityof
thisBoardto“overseetheoperationofthesystem”(Toma).Thebalanceinthe
FederalReserveiswellestablished.ItdoesnotneedapprovalfromtheUnited
Statesgovernmenttotakeactiononanissue,butatthesametime,itisresponsible
foritsownfundingandshouldnotlooktoCongressforcapital.
OnemajorbreakthroughwiththeFederalReserveActwasthatitconvinced
bankstoholdtheirreserveswiththeregionalbanksoftheFederalReserve
(McCulley297).Thispreventedbanksfromlockinguplargeamountsoftheir
reservesinnon‐cashassets.ThisalsogavetheFederalReservetheopportunityto
helpallbanksinatimeofpanicorcrisis,ratherthanjustthelargerbanks.Again,the
mainpurposeoftheFederalReservewastoserveasalenderoflastresortwho
couldprovideassistancetobanksintimesofpanic.Thelate1800sandearly1900s
sawahandfulofbankingcrises.Witheachoneitbecamemoreandmoreapparent
thattheUnitedStatesneededsomeformoflenderoflastresorttoprovidecapitalin
timesofcrises,aswellashandletaskssuchasadjustthediscountrateinattemptto
preventafinancialcrisisfromhappeninginthefirstplace.Overtime,theUnited
Stateshasexperienceddifferenteconomicshocks,aswellasexpansionand
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diversificationinitsfinancialsystem.Additionally,theFederalReservehasevolved,
withitsstructureandresponsibilitieschangingasneeded.Itsfoundingprinciples
stillexist,butnewassembliesofpeoplesuchastheFederalOpenMarketCommittee
havearisenwiththeneedfortheFederalReservetotakeonnewresponsibilities.
PassingtheFederalReserveActwasacrucialtimeinourhistoryasithashelpedto
lessentheeffectsoffinancialcrisesandstabilizethecurrencyoftheUnitedStates.
Comparison:ThePanicof1907relativetootherCrises
Ifthereisonethingthateconomistscanagreeon,itisthatfinancialcrises
arenothingnew.Financialcriseshavebeeninexistenceaslongasmoneyhas.While
eachoneisaseparateeventwithuniquecausesandeffects,economistsoftenfind
similaritiesamongthem.Forexample,asdiscussedearlier,afinancialcrisisdoes
notspringoutofnowhere.Theyallstartwithsomeformofpanic.Inthefinancial
crisisof2008,thetroublestartedwhenabubbleinthehousingmarketeventually
burst.Thepanicamonginvestors,however,startedwheninvestorsdiscoveredhigh
potentialfordefaultamongsubprimemortgagesgivenouttopeopletofinancetheir
homes(Tucker).In1906,anearthquakethatdestroyedmuchofSanFranciscoleft
thecountryinfinancialtroubleduetohighdemandforcapitalaroundtheworld.
Thesepanicsalsosharedsomeothersimilarities.Weoftenfindthatpanicscome
withwavesofthebusinesscycle.Inbothcases,1907and2008,thepanicsandcrises
followedperiodsofeconomicgrowth.TheUnitedStatessawstrongeconomic
growthintheearly1900s,precedingthePanicof1907,andsawstronggrowth
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againfromthelate1990sintotheearly2000spriortothatcrisis.Withmore
foresight,itisthoughtthatperhapsbothcrisescouldhavebeenavoidedaltogether.
Thepanicsof1907and1873shareothersimilaritiesaswell.Infact,both
developedintointernationalcrises(Kindleberger137).AswiththePanicof1907,
thePanicof1873occurredatatimewhencountriesaroundtheworlddemanded
capital.Muchofthiscapitaldemandcameascountriesbeganinvestinginmore
foreigngoods,suchastheGermansinvestinginAmericanRailroadsandUnited
StatesexportinggoodstoEuropeanmarkets(Kindleberger138).Anothercommon
linkbetweenthetwocrisesisthattheUnitedStateshadnocentralizedbanking
systemduringeitherpanic.Expertsbelievethathavingacentralizedbankcould
havelessenedthepanicsorpreventedthemaltogether,muchasEnglandwasable
tosteerthemselvesawayfromthecrisisintheearly1900s.OncetheFederal
Reservewasputinplace,theUnitedStateshadamuchbetterchanceofpreventing
financialpanicbecauseitnowhadasystemtocontrolinterestratesandprotect
capital.Ifpeoplehadnotbeenreluctanttoactandformacentralbank,perhapsthe
Panicof1907wouldnotevenbeapartofUSeconomichistory.
Conclusion
ThePanicof1907wasarevolutionarytimeinUnitedStatesfinancialhistory.
Thepanicwasafinancialcrisisthatcameontheheelsofanaturaldisaster.It
followedaperiodofbusinessgrowthandeconomicexpansionintheUS,andit
markedatimeofsignificantchangeintheUnitedStatesmonetarysystemthatisstill
ineffecttoday.Poordecision‐makingbyindividualscombinedwithpoorpolicyin
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thecountryleadtooneoftheworstfinancialpanicsinUShistory.Trustcompanies
failed,theUnitedStatesTreasurynearlywentbroke,andvariousotherindustries
felttheeffectsasunemploymentroseandindustrialproductiondeclined.
Thoughthecrisishadanegativeimpactonmanypeople,numerouspositive
thingscameaboutasaresultofit.J.P.Morgan,arguablythemostfamousbankerin
UnitedStateshistory,cementedhisplaceasoneofthemostimportantand
influentialaswell.HiseffortstopreservecompaniesandbanksinAmericawere
criticaltothesuccessandsustainabilityofthenation,atatimewhenthethreatof
thecountrydefaultingonitscurrencywasarealpossibility.
Inresponsetotheseproblems,thenationdevelopedoneofthemost
importantpoliciesinUShistory:thecreationoftheFederalReserve.SincetheUS
experiencedseveralfinancialcrisesinthe1800sandearly1900s,itbecame
apparentthattheUnitedStateswouldneedacentralizedbanktobackitscurrency
andprovidealenderoflastresort.TheFederalReservepolicyworkedoutwellfor
theUnitedStates,andithasanevenmoreextensiveroleinthemonetarysystem
today.
ThesignificanceofthePanicof1907washowtheUnitedStatesresponded.It
wasaturningpointinthecounty’shistoryintermsofmovingpastthenation’sfear
oftoomuchgovernmentcontrolinthewrongplaces.Previously,problemswere
ignoredandnochangesweremadeinresponsetootherfinancialcrises.Atthis
time,however,thenationlookedforchangestopreventfutureissues.Someofits
mostinfluentialcitizensactedasleadersduringthiscrisis.
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WhilemanythingswentwrongfortheUnitedStatesandmanyregardthe
Panicof1907asoneoftheworstfinancialcrisesinthenation’shistory,alotof
positivechangegrewfromit.Peopleprogressedandpoliciesemergedthatshaped
theUnitedStatesintothepowerfulfinancialinstitutionitistoday.
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