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To understand fully the crash and had disturbed the equilibrium of the
panici of 1907, one must consider its nations fragile financial system. As
context: it was a time somewhat like Mark Twain supposedly said, His-
the present. A Republican moralist tory may not repeat itself, but it occa-
was in the White House. War was sionally rhymes.
fresh in mind. Immigration was fuel- Exactly 100 years ago the United
ing dramatic changes in society. New States was teetering on the edge of
technologies were changing peoples economic collapse. Markets were in
everyday lives. Business consolidators disarray, anxious depositors were
and their Wall Street advisers were cre- forming long lines in front of banks,
ating large, new combinations through and Wall Street investors were ner-
mergers and acquisitions, while the vous and distressed. By November
government was investigating and 1907 a major market crash had
prosecuting prominent executives led resulted in a 37 percent decline in
by an aggressive young prosecutor from the value of all listed stocks, affect-
New York. The publics attitude toward ing nearly every industrial sector.
business leaders, fueled by a muckrak- During the sharpest part of this
ing press, was largely negative. The downturn, a banking panic led to
government itself was becoming the failure of at least 25 banks and
increasingly interventionist in society 17 trust companies.ii Money was
and, in some ways, more intrusive in increasingly scarce, brokerages were
individual life. Much of this was stim- forced to close, and the City of New
ulated by a postwar economic expan- York was twice unable to find buy-
sion that, with brief interruptions, had ers for its bonds, forcing the munic-
lasted about 50 years, although in ipal government to the brink of
recent months a major natural disaster bankruptcy.
and Gross & Kleeberg State Savings Bank of Butte America; and other Trust in the interior: money
know about the condition of financial National Bank of North America; companies; New York centers and small local
institutions. To resolve this asymme- New Amsterdam Bank; Mechanics Stock Exchange; Moore banks; foreign financial
& Traders Bank; Knickerbocker Trust. & Schley. institutions.
try, Morgan had privately chartered
audits of the assets of various institu-
tions and debtors. But he must have process of credit expansion and con- the risk of crisis. Like rapid growth
known that the more serious asym- traction that significantly amplifies and inadequate safety buffers, the mis-
metry lay not between him and the changes in markets and economic takes of leadership can help to foster
institutions, but between the public growth. The boom part of the credit an environment vulnerable to shocks.
and the institutions therefore, Mor- cycle erodes the shock absorbers that In 1907, Theodore Roosevelt was on
gan attempted to use the press, and cushion the financial system in the the warpath against anticompetitive
even the pulpits, to shape public per- slump. Some banks, eager to make business practices. He wielded the
ceptions about the safety and sound- profits, unwisely expand their lending power of the Department of Justice
ness of the financial system. to less and less creditworthy clients as and the Sherman Antitrust Act, and he
Buoyant growth. As lightning pre- the boom proceeds. Then some exter- used the bully pulpit to excoriate the
cedes thunder, a volatile environment nal shock occurs and the bank direc- malefactors of great wealth.
is a precursor to financial instability. tors awaken to the inadequacy of State governments followed suit
Indeed, volatility in the form of buoy- their capitalization relative to the with new legislation to limit railroad
ant economic growth may be espe- credit risks they have taken; banks rates; New York State employed a
cially pernicious since it engenders reduce or cut off the new loans avail- young prosecutor, Charles Evans
false optimism about the stability of able to their clients. This triggers a Hughes, to investigate the insurance
markets and institutions. Every major liquidity crisis that drives both a stock industry. The Supreme Court
financial panic has occurred after an market crash and a depositor panic. famously imposed a massive fine on
episode of rapid economic growthvi The fragility of such a system stems Standard Oil for rate fixing.
though not all panics are associated not only from the behavior of some Should Roosevelt and the Progres-
with recessions.vii Of special interest is banks. It also grows from the struc- sives really be implicated in the crash?
not the fact of growth, but rather the ture of the industry. A system with Financial markets withstand political
cause of the inflection, the downturn many small and undiversified banks bluster fairly well were Roosevelts
from boom to slump. Rapid economic such as existed in the United States speeches just empty rhetoric, we
growth creates a demand for money in 1907 is more prone to panics.x might absolve him. But markets are
that eventually imposes liquidity In addition, the economists Ellis highly sensitive to changes in govern-
strains on the financial system. Tallman and Jon Moen (1990) found ment policy (such as rate regulation,
The crash and panic of 1907 punc- that the emergence of trust compa- taxation, and antitrust enforcement)
tuated a period of very rapid eco- nies a relatively new and lightly reg- that affect the underlying drivers of
nomic growth in the United States. ulated financial institution intro- value. By late 1906, the radical shift
This growth created a massive duced a key source of instability in government policy was apparent.
demand for external finance and leading up to the panic of 1907. In Roosevelts speeches only confirmed
meant the financial system within the part, the unequal regulation of banks the shift. He was both messenger and
U.S. had a low level of capital relative and trust companies contributed to a message and thus deserves a place
to the recent rate of demand.viii New concentration of riskier assets in among the drivers of these events.
capital nearly $100 million in gold trusts; the trusts took advantage of Real economic shock. Research on
imported in 1907 was obtained opportunities from which the banks financial crises acknowledges the role
from Europe, through borrowings were restricted. Moreover, the trusts of some triggering event. Financial
denominated not in U.S. dollars, but were able to concentrate their portfo- crises require a spark. The history of
in sterling, francs, and marks. Large lios more.xi 1907 suggests there may be several
borrowings denominated in foreign Adverse leadership. Adding to the candidates. Adverse court rulings,
currencies have also been associated stew of uncertainty that leads up to rising regulation, and outlandish
with financial crises.ix the financial crisis is the action of rhetoric affected the atmosphere of
Inadequate safety buffers. The political and economic leaders who business confidence. But most notably,
business cycle is associated with a advertently or inadvertently elevate the San Francisco earthquake and fire
continued on page 34
The Panic of 1907: Lessons Learned from the Markets Perfect Storm
continued from page 23
sity of Chicago Press. This was also United States, 18671960. Princeton: Chicago Press.
published as a chapter by the same Princeton University Press. Moen, Jon, and Ellis W. Tallman. 1992.
title in Charles W. Calomiris (ed.). Gorton, Gary, and Lixim Huang. 2002. The Bank Panic of 1907: The Role of
2000. U.S. Bank Regulation in His- Banking Panics and the Origin of Cen- Trust Companies. Journal of Eco-
torical Perspective. Cambridge, tral Banking, Cambridge, Mass.: nomic History 52:611630.
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Donaldson, R. Glenn. 1992. Sources of Pan- MA: National Bureau of Economic Sprague, O. M. W. 1908. The American
ics: Evidence from the Weekly Data. Jour- Research, working paper 3400; and Crisis of 1907, Economic Journal
nal of Monetary Economics 31:277305. in R. Glenn Hubbard (ed.). 1991. (September):353372.
Friedman, Milton, and Anna Schwartz. Financial Markets and Financial Tallman, Ellis W., and Jon R. Moen. 1990.
1963. A Monetary History of the Crises. Chicago: University of Lessons from the Panic of 1907.