Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.
In the early 1900s, the US economy was booming. Average production was growing almost 8% per year and the United States was on track to surpass Britain as the world's largest economy. Wall Street was seeing this growth in the form of higher stock price and the general public was beginning to rely more on banks and trusts to hold their money. By all measures, the economy was strong.
Throughout the history of financial markets, when an economy is strong and investments are growing, some investors become more willing to take excessive risk and start participating in speculation. Speculation in the financial markets is best defined as when an investor is overly optimistic and starts to minimize the degree of risk in an investment. Speculation in housing prices led to the 'Great Recession' of 2008, and it was speculation in copper prices that led to the Panic of 1907.
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Before we get into the specifics about the Panic of 1907, there are a couple concepts that are important to understand. The first is the definition of a trust, or trust company. A trust is a company that operated much like a bank, but was not required to meet the same reserve requirements. The second is just that, the definition of reserve requirements. The reserve requirement is the percentage of deposits a bank is required to hold as cash.
For example, if a bank held $10 million in customer deposits and the reserve requirement was 25%, they would need to have $2.5 million in cash (25% of $10M). In the early 1900s, the reserve requirements for trusts was only 5%, making them especially susceptible to a run on the bank, when many customers demand cash withdrawals at the same time.
In 1907, two individual investors, Augustus Heinze and Charles Morse, started the panic that would eventually lead to a recession that lasted more than one year. Both Heinze and Morse were associated with banks and trusts on Wall Street. Together, they took a speculative investment in United Copper, a copper mining company. They lost, big.
The loss by Heinze and Morse was so significant that people were worried the banks that had loaned Heinze and Morse money wouldn't be able to cover the cash withdrawals requested by other customers. This fear led to a run on the banks and trusts associated with Heinze and Morse. It didn't take long for that run on the banks to spread, with other customers wondering if their banks and trusts had made loans just as risky to other investors.
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The total time period of the Panic was about one month, from October 9 to November 4. As mentioned earlier, it began with the failed attempt by Heinze and Morse to manipulate and speculate the stock price of United Copper.
Over the next few days, the runs on the bank began to intensify. The stock market started to react on October 15, when stock prices started to fall sharply. This perpetuated the runs on the banks and trust and led to one large trust, the Knickerbocker Trust Company, to collapse after banks announced they would no longer accept checks from Knickerbocker, because the banks were convinced Knickerbocker was not able to cash the checks.
As the stock market tumble continued, and more customers demanded their cash, banks and trusts were at the edge of collapse. They simply did not have the cash they needed to give their customers. While it took two men to begin the panic, it only took one man to stop the panic.
J.P. Morgan was the most well-respected financial mind of the day, and on October 24, when the New York Stock Exchange nearly collapsed, Morgan worked with his banking colleagues and injected $23 million into the banks to help stabilize the system. While $23 million does not sound like a lot, the 2016 equivalent of that much money would be over $560 BILLION dollars!
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While Morgan's cash injection into the banking system calmed the panic, the weakness of the banking system was clear. Outside of the U.S. Panic of 1907, smaller runs on banks had occurred in Japan and Europe earlier in 1907. This made investors and customers hesitant to move as quickly as they had in the years prior to 1907.
The Panic of 1907 triggered a recession that lasted more than a year. Unemployment had been lower than 3% but spiked to 8% in that time. Production in the U.S. dropped 11% and imports decreased by 26%. The crisis was felt by everyone.
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Begun by Heinze and Morse, two investors involved in speculation of the copper market, the Panic of 1907 was caused by a run on the banks. Because trusts had a lower reserve requirement than banks, the demands for cash from customers was perpetuated and quickly spiraled into a national crisis.
The panic lasted a month, but the recession it caused lasted a year. The panic was calmed when J.P. Morgan worked with his colleagues to raise $23 million to inject into the banks so customers could get their cash. While this helped stopped the run on the banks, the panic had already done enough damage to start a recession that would see unemployment increase from 3% to 8%, production fall 11%, and imports drop 26%. The Panic of 1907 was the worst financial crisis in the history of the United States, up until the Great Depression of 1929.
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