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The Panic of 1907
American Business History
The Panic of 1907
At the turn of the 20th century, a few devious men helped to expose the seismic deficiencies within the US banking system
In the early months of 1907, skies were bright within the United States. The Gilded Age brought forth an unprecedented period of expansion within the country, and the US economy had grown to become the largest in the world, supplanting that of the United Kingdom. As is so often the case, just as a sense of sanguine bullishness begins to set in, a storm begins to coalesce on the horizon.
By the end of the year, a panic would cause the New York Stock Exchange to plunge, a recession would be triggered, imports would decrease by 26%, and reverberations from the event would be felt around the world. The first global economic crisis of the century would also sow the seeds for the Federal Reserve System—a central bank within the United States which would emulate the macroeconomics of Europe.
The backdrop
Frederick “Fritz” Augustus Heinze was an American businessman born in Brooklyn to German immigrant parents. At age 20, he took his degree from the Columbia School of Mines and headed out to Butte, Montana as an engineer for the Boston and Montana Company. When his father died not long after, this hard-drinking, boisterous entrepreneur used his $50,000 inheritance to develop an advanced new smelter in the region. Unsatisfied with leasing mines to secure the ore for his smelter, Heinze stumbled across an area abundant with ore deposits and purchased the surrounding land.
With his gregarious nature and an uncanny political acumen, Heinze took on the two “Copper Kings” in the region and built what would become the United Copper Company, which produced some 40 million pounds of copper per year. After a tumultuous few years, filled with legal challenges and even hand-to-hand combat within the veins between miners of opposing companies, Heinze agreed to sell his Butte operations to one of the Copper Kings for $12 million. It was off to New York with his United Copper, where he planned on becoming a major financial force within the industry.
As fate would have it, the wealthy would-be potentate struck up a friendship with Charles W. Morse, a speculator and businessman of questionable character who had previously cornered the lucrative ice business in New York, gaining the moniker “Ice King.” (At the time, commercial ice was cut from lakes and rivers, taken to an ice house, and packed with straw and sawdust for insulation; remarkably, these giant ice blocks often had the ability to stay frozen until the following winter!) Morse attempted to use his monopoly to jack up the price of the frozen commodity, but his plan fell apart when it was revealed he had colluded with local politicians in exchange for a kickback.
Banks, trusts, and bucket shops
In the early 20th century, banks within the US operated with far fewer rules than they do today. With the ascendancy of America’s economic might came an increase in the demand for financial services, leading to a proliferation of trust companies to fill the void. Trust companies were subject to even fewer rules than the banks—a fact that would come back to haunt depositors. One such association was the Knickerbocker Trust Company, chartered in 1884 by a friend and classmate of J.P. Morgan. The firm served as trustee for individuals, corporations, and estates. By 1907, under the leadership of Charles T. Barney, Knickerbocker had become the third-largest trust company in New York City. That was about to change.
There was another component to the banking/investment environment in the early 20th century: a nexus between the two worlds known as a bucket shop. These seedy establishments were street corner “offices” which allowed for the betting on stock and commodity prices without the transfer or delivery of actual shares or goods ever taking place. These archaic derivative houses would ultimately be outlawed in the US, but they were a fixture within the financial zeitgeist of the early 1900s.
Cornering United Copper
It was Augustus Heinze’s brother, Otto, who originally hatched the scheme to corner the market on United Copper, the firm his brother built in Montana. Believing that his family already controlled a majority of the company, the plan was to aggressively buy more shares in an effort to run the price up, thus squeezing all of the bucket shop short sellers by calling the shares.
Ironically, Knickerbocker’s president had turned down the plan to fund the scheme when the two brothers and Morse presented it to him. Despite the fact that Augustus and Morse both sat on a number of bank and trust boards at the time, Barney warned that the plan was too risky and too costly for his trust company. Otto didn’t heed that warning when he began accumulating more shares despite the lack of funding, and the refusal would not insulate Barney from the carnage which would ensue.
When Otto put his plan into motion on Monday the 14th of October, he quickly drove shares of United Copper from the $40 range to around $60. To his shock and dismay, when he called the short sellers’ bluff on Tuesday, they had little problem finding enough shares (outside of Heinze family control) to meet his demands. By Wednesday, the stock price had collapsed to $10 per share. Otto’s fledgling empire was reduced to rubble.
While the New York Stock Exchange suspended Otto’s trading privileges, both his brother and co-conspirator Morse began losing their lucrative board seats. Banks holding large amounts of United Copper stock as collateral against outstanding loans began to fail.
Because of his relationship to Morse and Heinze, Barney was forced to resign, but that didn’t stop nervous depositors from yanking their funds out of the trust. Like a wildfire among dry brush, the panic quickly spread to other financial institutions.
The city’s wealthiest and most respected banker, J.P Morgan, decided it was too late to save Knickerbocker Trust, but he was able to staunch the bleeding at healthier institutions by cajoling a group of the city’s other trust presidents. Not only did the group agree to provide over $8 million in emergency loans to the Trust Company of America, Morgan persuaded John D. Rockefeller—the richest man in the world at the time—to pledge up to half his wealth to preserve the system.
Most importantly, Treasury Secretary George Cortelyou pumped some $25 million of government funds into several New York banks to instill confidence. None of these actions, however, soothed the nerves of investors, who began selling shares on the New York Stock Exchange at breakneck speed. When the dust settled, the Exchange had lost some 50% of its value from the previous year’s peak.
It would take more strong-arm tactics by Morgan (like locking the bankers in his library until enough funds were committed) and an intervention by trust-busting President Theodore Roosevelt to end the crisis, but the damage had been done. The banking system in America would never be the same.
From the gold standard to Jekyll Island
The shock waves at home from the Panic sent ripples across the pond to Europe. European banks had significant investments in America; investments which began to plunge in late 1907. Banks on the continent began to tighten standards, causing a slowdown in economic activity. Additionally, policymakers begin to question the viability—and limitations—of a monetary system built upon a country’s store of gold.
Back at home, the US Congress passed the Aldrich-Vreeland Act which established the National Monetary Commission. This group’s mandate was to identify ways to overhaul the banking industry. One glaring problem became clear: the country needed a central bank to manage the flow of funds.
One of the Act’s namesakes, Senator Nelson Aldrich, called a secret meeting—not publicly acknowledged until the 1930s—at a secluded island off the coast of Georgia in 1910. Six wealthy and powerful men met at the ultra-exclusive Jekyll Island Club to rewrite the country’s entire banking system.
The Aldrich Plan called for a system of 15 regional central banks which would make emergency loans to commercial member banks, and serve as a fiscal agent between the federal government and the banking industry. The Fed was born.
The Panic of 1907 led to a realization that global economies were intertwined as never before. Sadly, that fact would be borne out some twenty-two years later.
