The Panic of 1907 was the first worldwide financial crisis of the twentieth century. It transformed a recession into a contraction surpassed in severity only by the Great Depression.1 The panic’s impact is still felt today because it spurred the monetary reform movement that led to the establishment of the Federal Reserve System. Moen and Tallman (1999) argued that the experience of the Panic of 1907 changed how New York Clearing House bankers perceived the value of a central bank because the panic took hold mainly among trust companies, institutions outside their membership.

The central role of New York City trust companies distinguishes the Panic of 1907 from earlier panics. Trust companies were state-chartered intermediaries that competed with banks for deposits. Trusts were not, however, a central part of the payments system and had a low volume of check clearing compared with banks. As a result, they held a low percentage of cash reserves relative to deposits, around 5 percent, compared with 25 percent for national banks. Because trust-company deposit accounts were demandable in cash, trusts were just as susceptible to runs on deposits as were banks.

Despite their minor role in the payments system, trusts were large and important to the financial system. Trust companies loaned large sums directly in New York equity markets, including New York Stock Exchange brokers. Trusts did not require collateral for these loans, which had to be repaid by the end of the business day. Brokers used these loans to purchase securities for themselves or their clients and then used these securities as collateral for a call loan — an overnight loan that facilitated stock purchases — from a nationally chartered bank.2 The proceeds of the call loan were used to pay back the initial loan from the trust company. Trusts were a necessary part of this process, because the law prohibited nationally chartered commercial banks from making uncollateralized loans or guaranteeing the payment of checks written by brokers on accounts without sufficient funds.3 The extra liquidity provided by trusts supported new daily transactions on the floor of the exchange. Runs on trust company deposits, however, short-circuited their role as the initial liquidity provider to the stock market.

The Panic of 1907 had many elements in common with the financial crisis of 2007-09.4 Both crises started among New York City financial institutions and markets, and both affected the economy of the United States and the rest of the world. Examining the sequence of events in 1907 makes the parallels clear.

On October 16, 1907, two minor speculators, F. Augustus Heinze and Charles W. Morse, suffered huge losses in a failed attempt to corner the stock of United Copper, a copper mining company traded on the curb.5,6 After the collapse of this corner, the banks associated with these men succumbed to runs by depositors, who moved their deposits from dubious Heinze banks toward more reliable banks.

Four days later, the New York Clearing House made a public announcement that the Heinze-related member banks like Mercantile National Bank had been examined and deemed to be solvent, calming their depositors. The Clearing House also forced out the management of these banks, including Heinze and Morse. The New York Clearing House then offered these banks loans that were eventually exchanged for clearing house loan certificates, one of the benefits of membership in the Clearing House Association.7

While the Clearing House had been able to quash the runs on the national banks associated with Heinze and Morse, they were spreading to the trust companies. On Friday, October 18, news broke that the president of Knickerbocker Trust, Charles T. Barney, was an associate of Morse.8 The news sparked a run on Knickerbocker. The National Bank of Commerce extended credit to Knickerbocker Trust to cover those withdrawals.

The bank then requested a loan from the New York Clearing House on the behalf of Knickerbocker Trust on Monday, October 21. The Clearing House denied the request because its resources were reserved for the support of its member institutions. Knickerbocker and most other trust companies in New York were not members. After this denial, a request for aid was made to J.P. Morgan. He asked Benjamin Strong, then a vice president at Banker’s Trust and later the first head of the Federal Reserve Bank of New York, to examine Knickerbocker’s books and determine its financial condition. In the short period of time available, Strong could make no definitive determination of Knickerbocker’s solvency.9 Morgan therefore refused to aid the trust.

Also on October 21, Knickerbocker’s Board of Directors dismissed Barney on the basis of his personal connections to Morse.10 The National Bank of Commerce then announced that it would no longer act as Knickerbocker’s clearing agent. Following these announcements, the run on Knickerbocker intensified. The next day, after depositors had withdrawn nearly $8 million, it suspended operations.

The suspension of Knickerbocker Trust sparked the full-scale financial crisis in New York City. The runs on deposits spread among the trusts and were most intense at the Trust Company of America. Morgan changed his mind and quickly released aid, as did the New York Clearing House banks. However, depositors continued to withdraw funds from Trust Company of America for two more weeks.

An upward spike in the call money interest rate — the rate of interest on overnight loans on stock collateral offered at the New York Stock Exchange — was among the first signals of distress and tightening credit (see Figure 1). On the day Knickerbocker closed, October 22, the annualized rate jumped from 9.5 percent to 70 percent, then to 100 percent two days later. At times, there were no credit offers at that rate. The New York Stock Exchange remained open largely because of the legendary actions of Morgan, who solicited cash from large financial and industrial institutions and then had it delivered directly to the loan post at the exchange to support brokers who were willing to extend credit.