Mutual Funds for the Utterly Confused: The Panic of 1907
In the early part of our economic history, bank panics were somewhat commonplace. At one point, you could count on one about every twenty years or so. 1819 saw a panic erupt after the War of 1812. This occurred shortly after the establishment of the first central bank, something that Alexander Hamilton saw as incredibly important to the economic welfare of the country but Thomas Jefferson, another famous founding father objected to creating. Jefferson saw it as “a giveaway to the rich”.
Much of that panic in 1819 came at the hands of President Andrew Jackson, who did not like the idea of central banking (a Jeffersonian) and not only would not approve the creation of another central bank, he dismantled the first, leaving a void for such an important institution that lasted over seventy years.
Panics began to crop up with increased regularity. In 1836. President Jackson’s view of central banking as the “root of all evil” did little to help the rising economic prospects of the young nation. Foreign investors stepped in and extended credit where a central bank once have, and with so many currencies, goods being bought and sold, land being purchased and products being grown or developed at a pace unlike any previously seen, left the whole economy in a state of confusion. There was also a currency confusion brought on by overseas borrowing which created “redundancy of credit and of the spirit of reckless speculation engendered by it were a foreign debt contracted by our citizens”. We had a depression.
By 1857, the panic that occurred was due largely to improved telecommunications at the time. A business could run into financial difficulties hundreds of miles away, news that would have taken weeks or months to reach the financial capitals, was now available almost instantaneously. The telegraph caused yet another panic. When a branch of the Ohio Life Insurance and Trust Company failed, the stock market plunged, jobs were lost and food in the inner cities became scarce. Add to that, the over-speculation in railroads and real estate and you have yet another depressive reaction to a lack of central banking authority.
Jay Cooke and Company was a large and respected banking house, who had “helped the U.S. Government finance the Civil War and also underwrote the construction of the Northern Pacific Railroad. On September 18, 1873 it announced that it had failed.
This failure, reported in the morning New York Times panicked some investors who sold in the morning on the news. Other investors, having seen panics come and go in recent decades, held on as long as they could until they were no longer able to because of a margin call. This is the single most feared term in investments: a call to return the money the investor had used to borrow stocks. Once a stock reaches a certain level, the lender can demand refund and sell shares to obtain it. Remember, investors actually held paper stocks that needed brokers to transact the sale.
Railroads had been seen much the same way as the internet was less than a decade ago. Full of hope and promise and the way the future would unfold. Commodity prices were high and investors were pouring money into speculative bets that these prices would stay up forever. “August Belmont, J.P. Morgan and Henry Villard“, warned president elect Grover Cleveland that a panic was nearing, and used the opportunity to add pressure to get him to repeal of the Sherman Silver Purchase Act of 1890. Then, just before the inauguration, which was held in march not January as it is now, the Philadelphia and Reading railroad failed. Commodity prices on grain and steel fell through the floor.
J.P. Morgan is mentioned in the book for his spearheading of the notion of central bank and his ability and strength of will at bringing a coalition of bankers together to offer secured lines of credit to corporations that were being persecuted by the trust-busting efforts of President Roosevelt. Mr. Morgan also convinced the government to make deposits in these banks allow credit to unfreeze - at least temporarily. Even though there were now twelve banks spread across the country, lending money to each other, nothing central had been created nor was it very well coordinated. And then, “On February 26, The U.S. Congress passes a General Appropriations Act, including a provision increasing to $12,000 the annual salaries of Cabinet members, the Speaker of the U.S. House of Representatives, and the Vice President; and to $7,500 the salaries of members of Congress. On March 13, A financial panic begins with a sharp drop of the stock markets.”
Recent history (Panics in 1929, 1987 and most recently, 2008) has taught us that panics happen, although for different reasons and under vastly different circumstances. But generally, at the heart of all panics is over-speculation, poor understanding of credit and the belief that nothing could ever go wrong.
