THE FINANCIAL PANIC OF 1907

Popular opinion ascribed three reasons for the panic of 1907.  The first of these was the attitude of the President toward certain great corporations.  It is true that his attacks bared some of the most deeply rooted evils which have always been at the bottom of our panics-dishonesty in the administration of great aggregations of capital.  Great were the lamentations and doleful the predictions of what would happen should the President not change his policy of enforcing the laws.  The railway opponents of the President were sure the panic came from the Hepburn Bill, which was passed early in 1906.  If this had been dangerous to the welfare of the railroads it is reasonable to assume that foreign capital would have been withdrawn from American railways and that American capitalists interested in railroads would have attempted to avert financial ruin by disposing of their holdings.  Neither situation developed, for the European investors increased their holdings and American capitalists continued to plan still greater investments in railways.

The second general explanation was found in the unsound and reckless banking in New York City.  The dangers arising from trust companies had been known for several years.  It came to be believed that the deposits in these trust companies were being misused by the bank officers for the promotion of various speculating schemes.  The disclosures which came with the investigation of the insurance companies fixed these beliefs more firmly in the minds of the people, and the first break in confidence precipitated runs on the New York banks.

The third explanation was that the panic was due to the defects in our American currency system.

These were the popular explanations, but there were deep-seated causes which had worked to bring about the existing conditions.  The crisis was world-wide and was felt most in the countries where there was a gold standard.  In 1890 the world’s supply of gold available for monetary use was hardly $4,000,000,000; in 1907 it was more than $7,000,000,000.  Along with this went a rapid rise in the average price of commodities in gold-standard countries.  Bank deposits in the United States in 1907 were three times as great as they were in 1897.  Amidst all this prosperity there were forces which were bound to bring a reaction and among the most important of these was the demand for capital for conversion into fixed forms.  Ready capital was also lessened relatively by the great losses experienced as a result of the Spanish-American War, the Boer War, the Japanese-Russian War, the San Francisco earthquake, and the Baltimore fire.  These losses, which amounted to $3,000,000,000, came at a time when the world was just entering upon a period of great industrial activity and needed all its capital.  Much capital was absorbed in the construction of railroads, industrial plants, development of foreign industries, etc.  These conditions brought about a tightening of money rates in Europe and American financial centres; consequently rates of interest went up.  Commercial paper which brought three to three and one-half per cent in New York in 1897 brought seven per cent in 1907.

Closely allied to this movement was the increase in the number of securities issued by industrial concerns.  A few resourceful men, in order to do away with the evils of unrestricted competition, devised a remedy in the form of mergers.  Others of less capacity but greater daring saw opportunities for money-making, and a craze for mergers and for the incorporation of private enterprises swept over the country.  By 1907 there were at least $38,500,000,000 worth of securities in existence.  The natural result was speculation.  When investors began to fear the soundness of the securities a collapse of credit was due.

The rapid development of trust companies had its effect.  The cash reserves held by these companies were small; their investments were not always conservative and the depositors were often suspicious.  This free expansion of business with little or no reference to cash reserve or capital gave rise to another cause for the panic, which was not a matter of money.  It was a matter of what was in men’s minds.  There was a period of “muckraking” in which leaders financial and political were severely critcised.  Whether or not this criticism was justified by the exposition of the frauds of the insurance companies and the questionable dealings of some other corporations need not be discussed.  The criticism created an attitude of mind throughout the nation, and the first weakening of a bank brought on the deluge.

To the ordinary observer the panic of 1907 will date from October 22, when the Knickerbocker Trust Company of New York closed its doors.  Earlier in the month the Mercantile National Bank had gotten into difficulties and had appealed to the clearing-house committee for aid, which was given.  Soon it was noted that the Knickerbocker Trust Company was in a precarious condition, and the directors, following the example of the other bank, appealed to the same committee.  The investigation of the committee showed the company insolvent and aid was refused.  When the facts became known, a run on the bank began and it was compelled to close its doors.  The lack of confidence in other financial institutions was soon shown by similar runs.

No bank could stand the strain unaided.  Now the Federal Government stepped in and Secretary of the Treasury Cortelyou came in person to New York and deposited $40,000,000 of the surplus from the United States Treasury to be used for the aid of beleaguered institutions.  For more than a week the crowds of depositors sought their money.  The lines were not broken at night until the police hit upon the plan of giving to each individual a ticket denoting his place in the line.  The Trust Company of America alone paid $34,000,000 across its counters and still crowds thronged the streets.  At length the enormous reserve of the Treasury was exhausted and it became necessary to delay and deliberately to make slow payments.  Through loans made by other banks the Trust Company of America and the Lincoln Trust Company, which had endured the hardest sieges, were saved and now the panic entered its second stage.

The country was thoroughly aroused, and to avoid a nation-wide raid upon banking houses the bankers took radical steps.  The first measure resorted to was the enforcement of the rule requiring savings-bank depositors, at the option of the institution, to give sixty days’ notice before withdrawing deposits.  The second expedient was one which had been resorted to during former years of financial unsteadiness.  “Emergency currency” was issued.  This currency took various forms. (1) The clearing-house loan certificates issued in denominations ranging from $500 to $20,000, used for settling inter-bank balances; (2) clearing-house certificates in currency dimensions to be used by banks in paying their customers; (3) clearing-house checks which took the form of checks drawn upon particular banks and signed by the manager of the clearing-house; (4) cashier’s checks (in opposition to the National Bank act) secured by approved collateral; (5) New York drafts which were cashier’s checks drawn against actual balances in New York banks; (6) negotiable certificates of deposit, and (7) pay checks payable to bearer drawn by bank customers upon their banks in currency denominations.  These were guaranteed by the firm which issued them.

Other devices were used to aid the banks and to block the spread of the panic by limiting cash payments by the banks.  The governors of Nevada, Oregon, and California declared legal holidays continuously for several weeks, thereby allowing the banks to remain closed.  In some places the size of withdrawals was limited to $10 or $25 daily.

The panic was felt to a great degree on the New York Stock Exchange because the banks refused to make loans, but this stringency was relieved by a bankers’ pool, headed by J. P. Morgan, which loaned $25,000,000 at the prevailing rate of interest.  With the strengthening of the Stock Exchange another stage of the panic passed.

In spite of the use of the surplus of the Treasury the banks showed a loss of $50,000,000 in actual cash during the five weeks of the panic.  Now demands were made on foreign countries for gold.  The Bank of England made no move to block the great withdrawals of gold except to raise the official discount to seven per cent.  The flow of gold did much to stay the ebb of confidence.

Some contended for an issue of paper money and after a long discussion by the officials of the Treasury, it was decided to sell $50,000,000 worth of Panama two per cent bonds and $100,000,000 worth of three per cent notes in the hope of calling from its hiding-place the money which was being hoarded.  The result of the venture was not satisfactory and the loan operations soon ceased.

Gradually financial affairs righted themselves.  The emergency currency was redeemed, the runs on banks ceased, confidence slowly returned, and business picked up, although by the middle of 1908 the volume was scarcely half of what it had been a year before.  The number of bank failures had been comparatively small.  Only twenty-one banks were obliged to suspend payment, while in 1893 the number was 160.

Naturally there was much discussion concerning the defects of our financial system, of the needs of elastic currency, of a central bank, etc., when the Sixtieth Congress met in December, 1907.  Several bills were offered for the establishment of a central bank; some for the issue of a special currency by the government; others for the legalization of certificates and currency created by clearing-house associations.  The aversion of the people to the centralization of the banking business in the hands of a few of the great money powers made the establishment of a central bank out of the question.

The bills which were discussed at any length were the Fowler Bill, the Vreeland Bill, and the Aldrich Bill.  The first was discarded, although it had merits, and the two branches of Congress were unable to agree upon either of the others.  The result was a compromise measure which became the Aldrich-Vreeland Act.

The important provisions of this act are as follows:  (1) Ten or more national banking associations, each with an unimpaired capital and surplus of not less than twenty per cent and an aggregate capital and surplus of not less than $5,000,000, may form national currency associations.  These associations are to have power to render available, for the basis of additional circulation, “any securities, including commercial paper, held by a national banking association.”

(2) To obtain this additional circulation, any bank belonging to a national currency association having circulating notes outstanding secured by United States bonds to an amount not less than forty per cent of its capital stock, and having the required unimpaired capital and surplus, may deposit approved securities with the currency association and be empowered by the Secretary of the Treasury to issue additional circulating notes to an amount not to exceed seventy-five per cent of the cash value of the securities.  If the securities are State or municipal bonds the issue must not exceed ninety per cent of the market value of the bonds.

(3) The banks and assets of all banks belonging to the currency association are liable to the United States for the redemption of this additional currency, and the association may at any time require that additional securities be deposited.  All banks are held liable to make good the securities of any bank in the association.

(4) The total amount of circulating notes outstanding for any bank shall not at any time exceed the amount of its unimpaired capital and surplus, neither shall the amount of such notes in the United States exceed $500,000,000 at any time.  The amount issued in each State shall bear the same relation to the total amount issued in the United States as the unimpaired capital and surplus of the banks of that State bear to the unimpaired capital and surplus of the banks of the United States.

(5) The tax on circulating notes secured by United States bonds bearing two per cent or less shall be one-half of one per cent; if secured by United States bonds bearing more than two per cent, the tax shall be one per cent.  If the securities are other than United States bonds, the tax shall be at a rate of five per cent per annum for the first month and afterward an additional tax of one per cent per annum for each month until a tax of ten per cent per annum is reached.

(6) The redemption of the notes may take place by the banks depositing with the Treasurer of the United States lawful money to replace the securities deposited.

(7) The formation of a national monetary commission to inquire into and report to Congress necessary or desirable changes in the banking and currency laws was provided for.