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  Just as Paul Warburg had predicted, in the absence of a government bank, National City’s preeminent position thrust on it much of the responsibility of dealing with the disaster. For the moment, Stillman’s money trap was up to the task. One week later, Vanderlip reassured his mentor,

  The drain which California has put upon us gives indication of being at an end. Shipments there ceased two or three days ago. The total withdrawals of funds by California banks from New York and other centers will considerably exceed $30,000,000. . . . We have arranged to import $2,500,000 more gold which brings the total of the City Bank’s importation, as I am cabling you, up to $31,000,000.

  But money markets remained turbulent. In April and three times later that year, reserves in the New York banks fell into deficiency. Legally, this prevented them from extending new loans. What the banks needed was someone to supply them with additional reserves.

  Leslie Shaw did his utmost to facilitate gold imports—including providing a short-term loan of $10 million to National City. The Treasury secretary boasted that thanks to his efforts more than six carloads of gold, “largely in bars,” were imported from Europe, Australia, and South Africa. Moreover, he widened the practice of depositing and withdrawing government funds at strategic moments. It is worth listening to Shaw’s recounting of the languid summer of 1906, when

  granaries and warehouses were empty, freight cars stood on sidetracks, business men fished in mountain streams or rested at vacation resorts. Meanwhile the banks were comfortably well supplied with money, and interest rates were low. Everything seemed serene . . . except to those who recognized that in this latitude crops mature in the fall.

  Taking precautions, Shaw withdrew $60 million from national banks, lest it be used as tinder for stock speculation, and temporarily “locked it up.” Then, as cooler nights brought the approach of autumn,

  business men returned to their desks fresh for more intense activities. Crops began to mature, granaries and warehouses began to fill, freight cars were put in commission, checks and drafts were drawn in multiplied number and in multiplied amounts, while the people naturally carried in their pockets more ready cash than at other seasons. The strain inevitable [sic] began to develop. Interior banks [those in the country] called their loans. . . .

  With credit now in short supply, Shaw restored a portion of the funds previously withdrawn, “with great benefit,” he judged, “to the business interests of the country.”

  Shaw was not trying to increase the money stock, only to smooth the seasonal fluctuations—a modest goal by the standards of today. The total funds at his disposal were also modest. But his actions were seen as radical by his peers. It did not help matters that fully 11 percent of the government’s bank balances were parked with a single bank—National City. A Chicago banker, incensed over Shaw’s close relations with City (which was also the bank to Standard Oil), fumed that the public “had begun to smell kerosene on his wardrobe.” The Nation charged Shaw with aiding “a ring of powerful Wall Street speculators.” A similar charge had been leveled in the 1790s at Treasury Secretary Alexander Hamilton and, indeed, would be brought against the Federal Reserve during the financial crisis of 2008. It is a truism of capitalism that if money is injected into the system, no matter the intent, some of it will end up benefiting well-connected financiers. Shaw had at least tried to sprinkle his deposits around the country according to demand—in Boston, Louisville, Kansas City, New Orleans, Minneapolis, Buffalo, Omaha, and other cities—but the money ended up where interest rates were highest: in New York. “Money,” he dolefully observed, “is almost as liquid as water and finds its level about as quickly.”

  The charge of favoritism was, in any case, only a sideshow. The more elementary criticism was philosophical: that Shaw was encroaching in the money market, and this was still not thought to be the government’s concern. If the Treasury secretary could intervene in credit markets, the liberal Nation fretted, as if bewitched by a premonition of a modern central banking maestro, what would prevent some future “autocrat” from intervening in the stock market? In a more comprehensive critique, A. Piatt Andrew, a young assistant economics professor at Harvard, charged Shaw with skirting the law in various ways (which he had), and flatly declared, “Gold imports are not a matter of government concern.” No European central banker would have agreed.

  Andrew saved his most sizzling critique for the end. Why was it, he wondered, that the New York banks had fallen into deficiency with much greater frequency under this particular Treasury secretary? “Never before,” he noted, “had a Secretary declared that it was the place of the Treasury to intervene in banking operations outside of times of panic.” Evidently, he surmised, banks felt less need to keep their own reserve knowing that the Treasury was ready and eager to assist. This anticipated the “moral hazard” arguments against bailouts in the 2000s. “Outside relief in business, like outdoor charity,” Andrew concluded, “is apt to diminish the incentives to providence.” Andrew did not belittle the defects of the American system, or the need for reform, but he rejected “arbitrary and lawless interpretations” by an official “over whom Congress has little or no control.”

  Nearly everyone wanted to reform the banking system, but no two groups agreed on the remedy. Wall Streeters did not much worry that a central bank might favor powerful bankers (that was part of the attraction). Bankers in Gotham believed that American leadership in finance would redound to the country’s benefit, and also to their own. They had unselfish reasons as well as opportunistic ones, although it is unlikely that they examined their motives so finely. They simply felt that a stronger credit system would be good all around.

  Rebuffing Wall Street, Shaw immodestly suggested that the Treasury secretary himself be endowed with czarlike powers, which, he said, would enable him to avert any and all panics in the future. Senator Aldrich applauded this idea, which he believed would strengthen the existing currency, and dashed off a bill to enhance the secretary’s authority.

  Aldrich and Shaw were opposed by yet another constituency, Chicago’s bankers, who were concentrated on La Salle Street. Chicago bankers disliked Shaw’s proposal because they feared, justifiably, that an activist Treasury would work closely with banks in New York. For similarly parochial reasons, La Salle Street was opposed to a central bank.

  The Chicago bankers were important because they were a potent industry voice outside of New York; they also dominated the councils of the American Bankers Association. Under the leadership of James Forgan, president of the First National Bank of Chicago, the ABA championed a bill to expand the currency by letting big-city banks operate branch offices, through which they could distribute their own notes.

  But the prospect of branch banking horrified yet another group—small-town bankers, who reckoned that if banks in the city could open branches in rural areas, country banks would be overrun. And country bankers wielded considerable clout in Congress (more than a few congressmen were local bankers). With the banking industry so fractured, and with Roosevelt not daring to break the impasse, reform efforts were stalemated. As one western observer put it, “The bankers are still divided; who shall decide when doctors disagree?”

  Nicholas Murray Butler, president of Columbia University, acknowledged the lack of leadership on a visit to Germany, where he was received by Wilhelm II. The Kaiser inquired who managed the confusing business of American finance. With a fatalistic air, Butler replied that the system was run by “God.”

  Warburg diagnosed the Americans’ malady as a fear that any reform would result in either the government’s or Wall Street’s gaining control, each an outcome dreaded by the public. Warburg would write that an “abhorrence of both extremes”—he might have said an abhorrence of power—“had led to an almost fanatic conviction” in favor of complete decentralization.

  Thus far, Warburg had followed Schiff’s advice and kept his views from the public. However, at the end of 1906, he
found himself at a dinner with a group of bankers and economists at the home of Columbia professor Edwin Seligman. The discussion turned to the financial outlook, which many considered ominous. Warburg distilled, with his trademark clarity, just why the American financial system remained so vulnerable. His host was spellbound.

  “You ought to write. You ought to publish,” Seligman said.

  “Impossible. I can’t write English yet—not well enough for publication.”

  Seligman insisted. Appealing to Warburg’s growing attachment to America, he added, “It’s your duty to put your ideas before the country.”

  The gestation period was remarkably brief. On January 6, 1907, readers of The New York Times awoke to Warburg’s first published American article, “Defects and Needs of Our Banking System.”

  “The question of the reform of the currency system is uppermost in the minds of all,” Warburg began. Mincing no words, he likened America’s system to that of Europe “at the time of the Medicis,” that is to say, in the fifteenth century.

  Warburg stressed that a central bank was a requisite for developing deeper, more liquid credit markets. Even in a second tongue, Warburg waxed poetic over the centralized systems of Europe, where “the credit of the whole nation—that is, the farmer, merchant, and manufacturer . . . becomes available as a means of exchange.” Warburg wanted Americans to see that their system was weakened by its lack of unity. He vividly compared its banks to the infantry in a disorganized platoon. “Instead of sending an army,” he admonished, “we send each soldier to fight alone.”

  By the time his article appeared, New York bankers had grown exceedingly edgy. The longer the boom went on, the more it relied on credit, and many felt that credit was overextended, as in a party too merry with drink. While no domestic authority existed to take away the punch bowl, America was highly sensitive to the decisions of European central banks, in particular the Bank of England.

  The view in Britain was that America’s feverish economy could use some cooling down. With loan growth so rapid, the pyramid of credit was perched on a precarious base. Was this a bubble? The Bank of England only knew that it would no longer be responsible for financing America’s expansion—particularly because the boom in the United States had been draining England’s gold. As Vanderlip was to report to Stillman, “The Bank of England is extremely nervous on the subject of gold exports.”

  In the fall of 1906, the Bank of England took away the punch. London raised its interest rate from 3.5 percent to 6 percent. The Reichsbank in Berlin raised rates as well. Since international capital ever flows to where the yield is highest, these moves inevitably induced investors to ship their gold back across the Atlantic. The Bank of England further insulated the mother country from the overheated American economy by directing British banks to liquidate the finance bills—short-term loans—that they provided to American firms, thereby tightening credit. In the aftermath of the ensuing panic, Oliver Sprague, an assistant professor at Harvard and a reputable financial writer, judged that this was the turning point. Eighty years later, Richard T. McCulley reached a similar conclusion. When the Bank of England reversed the gold flow, McCulley wrote, “the Wall Street boom punctured as easily as a soap bubble.”

  Wall Street tried to replace British loans with domestic credit, but American banks, having grown so quickly, had reached a point of exhaustion. Toward the end of the year, the stock market broke. Preparing for the worst, National City tightened its lending. Vanderlip protested, but Stillman smelled a recession, possibly a nasty one. “I have felt for some time,” he wrote early in 1907, “that the next panic and low interest rates following would straighten out a good many things that have of late years crept into banking.” Stillman’s bank had emerged from the Panic of 1893 in a stronger position relative to competitors; he expected that prudence would pay off again. “What impresses me as most important,” he informed his chastened subordinate, “is to go into next Autumn ridiculously strong and liquid.”

  The economy remained resilient into April, the mood in the heartland one of “buoyancy and hopefulness”—so reported George W. Perkins of the House of Morgan to J. P. Morgan, America’s most eminent financier. But the view on Wall Street, Perkins noted, was darker.

  What bankers found depressing was that banks were refusing to lend. Firms with illiquid assets were becoming nervous. As Perkins wrote to Morgan in May, there were “a great number of people and houses very very closely tied up with assets that they cannot either sell or borrow [longer-term] money on.” A subsequent note was nearly despairing. “As to money,” Perkins wrote, “there is still a distinct disinclination on every one’s part to make loans for any length of time.”

  Shaw had exhausted the capacities of the Treasury—always more limited than his critics granted. What’s more, the pounding from the press had taken its toll. In March, he resigned, replaced by George Cortelyou, a political adviser and intimate of Roosevelt who was rather more timid.

  Senator Aldrich, sensing the limited room for maneuvering, steered his currency bill through Congress, but it was altogether a modest one. When the bill was enacted, on March 3, the Times gratefully exhaled, describing the Aldrich bill as “a partial fulfillment of hopes that have long been entertained by the financial community for a betterment of our monetary system.” It was, in fact, no such thing.

  Just as the bill was signed, stocks broke again—this time sharply. Many railroad stocks fell 50 percent before the month was out; Union Pacific, a bellwether issue, plunged 25 points in a single day. In May, business began to contract. Although the recession of 1907 began as a modest one, at the end of May, Perkins confided to the venerable Morgan, who was spending much of his time on the Continent, “No [one] seems to have confidence in anything. . . . Call money is almost unlendable.” Longer-term funds were even scarcer—and the crops were still on the vine. With an eye on the unforgiving harvest calendar, Perkins concluded gloomily, “There seems to be a general feeling that we are likely to have a pretty serious time next Fall.”

  CHAPTER FOUR

  PANIC

  A panic grows by what it feeds on.

  —WALTER BAGEHOT

  Who is to be Mr. Morgan’s successor?

  —IDA TARBELL

  IN THE FALL OF 1907, America suffered the worst breakdown in the history of the National Banking system. Overnight, banks were stripped of reserves and the country was plunged into a severe depression. Cash (or its equivalent in gold) was all that people wanted, and cash vanished from circulation due to people’s very attempts to secure it. No agency of government was able to stem the panic. George Cortelyou, the new Treasury secretary, had neither the capacity nor the desire. “The present head of the department,” he wrote of his own relatively modest efforts to relieve the crisis, “has not assumed the obligation willingly and would be glad to be relieved of it at least in part by suitable legislation.”

  The word “panic” springs from Pan, the mythological god of the wilds, depicted as a man with the horns, legs, and tail of a goat, who played on panpipes and who aroused fear among solitary travelers in the forest. The Panic of 1907 generated, according to Frank Vanderlip, a “sudden, unreasonable, overpowering fright” that swept through “all the human herd.” In the thick of the crisis, Vanderlip encountered a prospective client, a promising young author by the name of Julian Street. He was clutching fifty thousand-dollar bills—his wife’s inheritance. Previously, Street had kept the money in a trust, a lightly regulated form of bank. He had gone to the trust to withdraw his money. There, the trust officers tried to dissuade him. They argued with him and cajoled him. “For your own good, Mr. Street,” the officers wailed, beseeching him to leave his funds. “Cash!” roared the author. “I want the cash!” Came the reply—“Not so loud, please, Mr. Street.” But Street’s cries echoed throughout the city, then throughout the land.

  After a decade-long boom, Americans had come to think of prosp
erity as a given and of the financial system as robust. Rapid electrification, new techniques for mass production, and a population that had soared to 80 million had made the nation an industrial power. Businessmen believed America would never again have a panic such as in 1893. Except for the urgings of a few financiers, mostly in New York, the impetus for banking reform had languished. Most Americans were uninterested, content with the quaint decentralized system of National Banking. The Panic of 1907 shattered their complacency overnight.

  Even Wall Street was caught off guard. Such crises always arrive as a shock, even to those who had sounded alarms. That summer, the level of industrial activity was weak but far from alarming. George Perkins, the Morgan partner, wrote to his eminence of “a little let-up in general business.” The New York money market tightened in the fall, but bankers had seen that before. In October, Theodore Roosevelt felt relaxed enough to disengage from his constitutional duties and spend a fortnight hunting in the wild canebrake country of Louisiana (on the thirteenth day, the President shot and killed a black bear). More telling was that J. P. Morgan, having returned from Europe in mid-August, took leave from Wall Street again. The banker, who when not working or acquiring art took his greatest solace in religion, was in Richmond, Virginia, attending a convention of Episcopalians. The missives he received from Perkins were singularly soothing. “There is nothing special to report,” the latter wrote him reassuringly. On October 12, Perkins dwelled on pleasantries, noting: “We are all very well, and having fine weather, and hope you are as fortunate.”