The Panic of 1907: Lessons Learned from the Market's Perfect Storm

This small book does a good job of explaining the Panic that led to the creation of the Federal Reserve Bank. In 1907, JP Morgan was powerful enough, and the world of finance was small enough, that one man could stem the tide. He was 70 years old and had had enough experience to know what to do. His reputation was such that others would take his advice. The story is well told and I was willing to give the authors one more star for their observation that John Maynard Keynes' 1936 recommendation for government counter-cyclical spending during recessions was quickly distorted by politicians to mean government spending in both boom and recession. That led to our present problems with deficits and discredited Keynes. That observation alone convinced me that these authors should be taken seriously. I recommend the story although, as others have pointed out, more information on the role of the gold standard would have been helpful. Morgan was a fascinating figure worth more attention as a cultural icon. It is appropriate that Caleb Carr includes him as a hero in his novels about the same era. A fine little book on economic history.

You should never take at face value the claims and declarations of politicians, public relations people, or journalists about the state of the economy. What you are being told is too often self-serving, manipulative, or ignorant. Remember that I said "at face value" because the truth is probably out there, but you will have to dig to find it. History is a good place to dig because in the hands of a careful historian or reporter, the distance of time provides some perspective, the facts are more fully known, and the events can be seen in the context of similar events. The danger is always to judge the past by what happened afterwards as if the people at the time had some knowledge about the path they were heading down with anything more than hope and guesswork. The banking industry in the United States has suffered from periodic panics throughout its history. Much of this had to do with the fragmented and local nature of the institutions and how a real or imagined crisis can start a small fire in one bank that spreads as depositors and investors rush to try and recover their savings before the bank fails. Much of this has to do with the fact that banks are highly leveraged institutions. That is, they loan out the same dollars multiple times for businesses, to buy homes, and other purchases. We all benefit from this. However, if all depositors want their deposits at the same time, there simply is not enough to go around and the bank will quickly collapse without access to other capital. This ready access to a supply of sufficient capital is called liquidity and in earlier times without a federal bank there was no standard mechanism ready to supply it. While some disagree, it seems clear to me that our present economic difficulties would be far worse without the Federal Reserve, some bank regulation (we have too much), and some level of deposit insurance. None of this existed in 1907. The San Francisco Earthquake and subsequent fire was so costly that it damaged the global economy. The following year there was a series of events that nearly wrecked the national economy. We don't talk about 1907 much nowadays, but it was this panic that led to the founding of the Federal Reserve and other banking reforms. This very interesting book by Robert Bruner and Sean Carr takes us through the events of the post earthquake economy that also suffered from the attacks on big corporations by Teddy Roosevelt's Progressive administration. The panic was set off by the disastrous attempt by Otto Heinze to corner the copper market and short squeeze the speculators he just knew were out there, and the tsunami that spread out from the failure of United Copper to banking and trading interests. The relationship of these events to the institutions involved is told in a clear and lively way. The story of this important period centers on the personal credibility and financial power of one man, J.P. Morgan. He knew what to do and had the personal clo

Shortly before 10:00 on the morning of November 14, 2007 Charles T. Barney walked into his second-story Park Avenue, took the pistol containing three bullets kept there for protection and fired one bullet into his head. Up to that moment, he was a man of the Gilded Age. The son of a prosperous Cleveland merchant, he married into the Whitney family, was a director of 33 companies and had served as the top officer of the Knickerbocker Trust Company up until a few short weeks prior. He had been asked to resign. The reason: early the previous month, he, along with several other New York City trust companies had funded an attempt to corner the market in the stock of a copper mining company. The attempt had failed. As word of his involvement spread, his investors and depositors panicked and started a run on his bank that would eventually lead to its closing. The country had lost confidence in its financial system. It would take leadership, largely from one man, J. P. Morgan, to restore it. Robert F. Bruner and Sean D. Carr take the reader day-to-day through this crisis. Beginning with the famed San Francisco earthquake and culminating with Barney's suicide, they draw seven lessons that are, perhaps more instructive today, than they would have been in 1907. They are: 1. Complexity makes it difficult to know what is happening and establish linkages that enable the crisis to spread. 2. Economic expansion creates rising demands for capital and liquidity. The mistakes that accompany those rising demands must eventually be corrected. 3. In the late stages of an economic expansion borrowers and creditors overreach in their application of debt. This lowers the financial system's safety margin. 4. Prominent public and private figures provided adverse leadership. Their policies raise uncertainty, lower confidence and elevate risk. 5. Random events shake the economy and financial system. 6. Greed becomes fear. 7. Well-intended responses prove inadequate to the crisis' challenge. This book drips with insight. Well-written, easy-to-read, it should be read by banker, traders and students of business and economics. It is a rare dissection of how and why a panic unfolds.

Edwin Lefevre's anecdotal account of the cash crunch of October 1907 in his timelessly street smart REMINISCENCES OF A STOCK OPERATOR (1923) has always begged for further commentary. His colorful recollection of how J.P. Morgan "saved" the New York Stock Exchange - "A day I shall never forget, October 24, 1907" - is in this current history placed in the larger context of a more general U.S. monetary crisis. Contributing events included the sudden, unexpected demand for capital following the San Francisco earthquake (1906), a Bank of England decision to slow the flow of gold to the U.S., a recklessly leveraged stock scheme hatched on Wall Street, and the absence of a central banking authority. Plunging asset values, impaired loan collateral values, a general loss of confidence, bank runs, financial ruin, and personal tragedy were the consequences of a "panic" that gripped the markets in that year. Even as one private individual, J.P. Morgan, provided the leadership and liquidity to the banking system, the City of New York, and the New York Stock Exchange, the events of 1907 dramatically underscored the need for a central bank to watch over the monetary needs of the country. The U.S. Federal Reserve as a lender of last resort was created in 1913. The authors summarize the lessons of 1907 in a final chapter. I'm not sure that new ground is broken here, and the "perfect storm" cliche' is overdone these days, but it can be forgiven in this highly readable account. The point is that multiple contributing causes are in evidence in a financial crisis. Among those causes that stand out are an economy growing strongly where potential risks are marginalized (e.g. the recent mortgage meltdown), financial structures so interlinked or complex that no adequate overview can anticipate the impact of a failure (e.g. the size and opacity of the hedge fund industry), an exogenous shock (e.g. terrorist attacks of 2001), and a financial accident (e.g. a major bank or hedge fund collapse) that crystallizes the risks for the public. Market transparency, coordinated leadership, and adequate regulation are seen as critical elements in slowing the spread of contagion. The authors don't go out of their way to look for these contemporary parallels, but the links are unavoidable. The strength of this book is that it is a page-turning, 'great read' with the added benefit of providing some useful, cautionary measures to help spot the next financial crisis.

Bruner's book is a must read for anyone interested in the history of American finance, or in the intricacies & complexities of financial crises in the US & elsewhere. The 1907 Panic was at once a watershed event in US finance, since it was the immediate stimulus for the creation of our first real central bank, the Federal Reserve. But it also was (and is) typical of financial crises generally. Those of the 19th century that immediately preceded it (that is, in the post-Civil War "Gilded Age"), and those of our own time (that is, Enron, Long-Term Capital Management, Continental Illinois, etc.). Bruner has done an fine job digging up the details of what actually happened in the October/November 1907 crisis, the personalities & institutions, and in showing how these events overlaid on an already unstable economic situation that were lowering public confidence. The book is very well written, if not novel-like, certainly approaching the form. I read nearly all of it in one sitting.