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  The trouble started with a case of misbegotten speculation that arose, as is often the case, in a remote province of Wall Street. A well-known and rather notorious Montana copper magnate had managed to seize control of a modest New York financial institution, the Mercantile National Bank. He then used the bank to finance an attempt to manipulate a copper-mining stock. In October, the manipulation collapsed, putting the Mercantile in jeopardy. The bank’s depositors now displayed a keen interest in withdrawing their money, and the Mercantile sought help from the New York Clearing House, the institution that settled balances among member banks and could also provide emergency loans to members. Assistance was provided to the Mercantile on condition that its wayward president resign. There, the disturbance might have ended.

  However, banking in New York was particularly exposed due to the emergence of the trusts, whose assets had swelled over the previous decade because of their willingness to pay higher rates of interest. Trusts had begun as quiet repositories for trust funds and estates, but over time they started to mimic the lending and deposit-taking operations of banks. They also invested in riskier assets than banks, such as real estate. Trusts could do this because they existed outside the regulated ecosystem of National Banking—not unlike the way, in a future generation, special off-balance-sheet vehicles would help commercial banks to circumvent the rules. Indeed, in the panic that began one hundred years later, it was a non-bank, Bear Stearns, where the trouble started, and for similar reasons. In 1907, more than 40 percent of all deposits in New York were parked in trusts—on the periphery of the financial system. And while a dollar in the national banks was backed, on average, by 25 cents of cash in the till, each dollar in the trusts was supported by only 6 cents. This meant that trusts had far less protection for a rainy day.

  Not only were the trusts vulnerable individually, but they (like banks in general) were linked by a chain of interlocking boards or, as it were, by a chain of reputation. The collapse of the Mercantile drew attention to another of its directors, a certain Charles W. Morse, who had interests in, and sat on the boards of, no fewer than six other local banks, three of which he controlled. Morse was a shady operator; his business methods, Oliver Sprague tactfully observed, “had been of an extreme character.”

  Now, with unease spreading, two of the Morse banks were forced to seek assistance from the New York Clearing House. In return, Morse resigned his positions, a development The New York Times reported with relief. However, Morse seems to have ratted out one of his confreres, Charles T. Barney, a central figure in developing the New York City subways and the president of a considerably larger institution, the Knickerbocker Trust Company. Barney and the unsavory Morse were partners in various deals, and their association rattled the Knickerbocker’s depositors. Thus the bad coin passed from hand to hand. By Saturday, October 19, when the seventy-year-old Morgan boarded a private railcar to return to New York, he was aware of a widening crisis.

  The next day, Morgan assembled a command staff consisting of himself, James Stillman, and George F. Baker, who for thirty years had been president of the First National Bank of New York. This venerable trio appointed a small team of younger bankers to evaluate the worthiness of troubled banks and determine which might merit assistance. Henry P. Davison, vice president of Baker’s First National, directed this team. Davison was immediately confronted with a crisis at the Knickerbocker, which, as a trust and a non–Clearing House member, was deemed ineligible for assistance. The New York Clearing House, in other words, took a narrow view of its role, and no institution with a broader mandate existed. Barney resigned and, with time running short, Davison dispatched Benjamin Strong, his thirty-four-year-old protégé, to inspect the failing trust’s books.

  The Knickerbocker was housed on Thirty-fourth Street and Fifth Avenue in an opulent, Corinthian-columned temple designed by Stanford White. The sidewalk in front was besieged by a mob of depositors, some of whom bore satchels with which they hoped to carry off sackloads of cash. Inside the bank, “stacks of green currency, bound into thousand dollar lots, were piled on the counters beside the tellers,” so reported the Washington Post.

  As Strong went over the books in the rear of the bank, he could hear depositors in the green-marbled public area clamoring for their money. He later wrote, “The consternation of the faces of the people in that line, many of them men I knew, I shall never forget.”

  By a little after noon on Tuesday, October 22, the Knickerbocker had paid out $8 million; it then suspended operations. Strong reported that he could not, in such little time, vouch for the Knickerbocker’s solvency. Morgan, therefore, decided not to intervene. In letting the Knickerbocker fail, Morgan knew he would be unleashing frantic runs on every other trust in the city. The resulting panic, as Schiff had predicted, made previous debacles look like child’s play indeed.

  Secretary of the Treasury Cortelyou hurried to New York on the afternoon train. He met that evening with a coterie of bankers—“with Mr. Morgan presiding,” the Times reported. In a later era, no private banker would think of holding court over his federal overseers. Notwithstanding that Morgan’s was a private bank, far smaller than the big commercial banks, Pierpont Morgan had, by a country mile, more prestige than any other banker in America. By force of reputation, he stood the best chance of corralling other banks into a cooperative rescue effort, and he was the man to whom the others turned.

  The next day, a furious stampede struck the Trust Company of America, the city’s second-largest trust, and also other trusts. Strong, once more, was sent to inspect the books. When he returned to the Morgan office, at 23 Wall Street, he found Morgan with Stillman, Baker, Perkins, and Davison. He told the group that although Trust of America’s surplus had vanished, it remained solvent. Calmly, Morgan said, “This, then, is the place to stop this trouble.”

  Morgan had not been previously acquainted with Strong. He placed confidence in him on the say-so of Davison, whose unflappable steadiness was perfectly calibrated to put the eminent banker at ease. Harry Davison had been reared in Troy, Pennsylvania, the son of a farm implement salesman. He was orphaned early and went to work for a small bank, where he laboriously copied figures in a leather-bound book. Davison was a striver, ambitious but possessed of an easy manner and gracious charm, qualities that sped his rise from small-town banking to the pinnacle of finance.

  Davison was close to Strong partly because the latter had also tasted hardship. Strong had been raised in a comfortable family, but his father suffered a financial setback, forcing Strong to forgo college—a bitter pill. He entered the trust field and caught the attention of Davison, who was five years his senior, and his neighbor in the bedroom community of Englewood, New Jersey. Through Davison, Strong joined the up-and-coming Bankers Trust, and seemed on the verge of a bright future. In 1905, however, Strong’s wife became depressed and, one day, while her husband was at work, availed herself of a revolver that had been purchased to ward off burglars, and shot herself. Davison, recalling his own lonely childhood, felt compassion and took in Strong’s children. Thus the two had a bond.

  By the time Strong reported to Morgan, Trust of America had less than $200,000 in the till. The Morgan group approved an emergency loan, on condition that the borrower show sufficient collateral. Employees of the beleaguered trust ferried boxes of securities to 23 Wall Street, and Strong and Morgan sat around a table assessing their worth. “Mr. Morgan,” Strong recalled, “had a pad in front of him making figures as we went along.” When Morgan was satisfied as to the collateral’s value, he would notify Stillman, who was in an adjacent room. Then, Stillman telephoned his underlings at National City Bank, which promptly supplied the requisite cash, with the loan to be divided among a syndicate of banks.

  But the panic did not subside. On Thursday, October 24, frightened trusts pulled their loans to the stock market—laying bare the domino-like fragility of American credit. Desperate stockbrokers offered to pay 125 percent
interest on call loans (short-term loans that were callable at any time). With dozens of brokers on the verge of failure, the president of the New York Stock Exchange threatened to shutter the market. Morgan felt that closing would be a mistake. He summoned the bank chiefs to his office and in roughly a quarter of an hour obtained a pledge for $23.5 million to shore up the market. National City committed to the largest share, $8 million. Stillman was discovering—true to Warburg’s prophecy—that his bank’s granite strength foisted on it unwanted responsibility in a crisis. The next day, the fifth straight of panicky conditions, the call rate on the stock exchange for overnight loans soared to 150 percent and the Morgan syndicate had to pledge $10 million more.

  By then, a new crisis was erupting: New York City was running desperately short of cash. Morgan summoned Baker and Stillman to his private library, a palazzolike structure adjacent to his home on Madison Avenue and, once again, the bankers arranged for an emergency loan, which kept the city government afloat.

  Morgan, of course, was not the only one to provide assistance. Over a period of four critical days, Secretary Cortelyou deposited $35 million in the city’s banks. However, at that point, the Treasury’s surplus was exhausted.

  Now more than ever, Morgan became indispensable. He filled the vacuum of central banker like a Medici prince, holding council in the evenings in his library, which was studded with hanging tapestries, ancient Bibles, and rare medieval manuscripts. Frequently he met with Baker and Stillman, and with the unflappable Davison, into the late hours. One night, as the group debated the merits of a rescue, Frank Vanderlip was also present; Morgan puffed on his cigar, which was rolled in his particular style, forming a bulge at the outer end. After a bit, Vanderlip noticed the hand that was holding the cigar had relaxed on the table, and Morgan’s head had sunk forward. Vanderlip would write: “We sat quietly, saying nothing. The only sound that could be heard was the breathing of Mr. Morgan.”

  Morgan’s centrality was so critical that the Times reported, worryingly, when he caught a mild cold, which was blamed on exposure to night air. Briefly, this private man was the toast of the town. Floor traders on the stock exchange burst into an ovation in jubilant thanks for his efforts. Grateful tributes streamed in to 23 Wall Street, some from far-flung correspondents. The letters, which pinned to Morgan’s chest the medal of savior, raised the question of his role in the economic system and whether it could be relied upon in the future. Jacob Schiff bluntly declared, “You stand between us and financial chaos.” A handwritten note from a banker in Memphis asserted that it was the general impression that “the safety and welfare of the financial structure of this country depends almost entirely upon you.”

  But Morgan was edging into retirement, as were Stillman and Baker. They would not be around forever. And Morgan’s efforts, however laborious, were not enough. New York’s trusts lost a remarkable (and devastating) 48 percent of their deposits. Even worse, at the end of October the New York Clearing House was forced to take the drastic step of authorizing banks to settle accounts with one another via certificates—paper substitutes for money—rather than with cash. The Panic had now reached epic proportions. The Clearing House “loan certificates” were backed by loans of the member banks. They were IOUs—promises to pay cash when cash became available. They were a form of invented money.

  With panic spreading, clearinghouses and bank associations in scores of other cities minted their own versions of clearinghouse money. Some were elaborately engraved to give the appearance of normal currency. The certificates were intended to be used only among banks, so that cash could be preserved for ordinary depositors. In a crude way, they added to the money supply—later a function of the Federal Reserve. However, in more than a score of cities banks were forced to hand out loan certificates not just to their fellow banks, but to ordinary depositors.

  Many railroads, mining companies, and shopkeepers paid workers with bank checks instead of with cash; those that didn’t had little choice but to suspend operations. In Birmingham, Alabama, banks distributed checks signed by their cashiers in denominations as small as one dollar to local employers—who used this scrip to pay their workers. Retail establishments generally accepted such paper, since that was all that many customers had.

  By mid-November, approximately half of the country’s larger cities were using loan certificates “or other substitutes for legal money,” according to a survey conducted just after the Panic by Harvard’s Professor Piatt Andrew. Loan certificates had been used in previous panics, but never so extensively. In some smaller towns where no clearinghouse existed, the local bankers improvised, setting up a temporary committee, as it were, on the front porch. Bankers tried to reassure the public, noting that certificates were backed by “approved securities.” Some added piquant details. In Portland, Oregon, the clearinghouse boasted that banks had deposited notes secured by “wheat, grain, canned fish, lumber . . . and other marketable products.” Monetary exchange was reverting toward barter.

  Andrew estimated that $500 million of cash substitutes of one form or another were circulated nationwide. And in two-thirds of cities with populations above 25,000, banks suspended cash withdrawals “to a greater or less degree.” For example, in Council Bluffs, Iowa, a limit was imposed of $10 per customer; in Atlanta, $50 per day and $100 per week. Banks in Providence, Rhode Island, adopted a convenient policy of “discretion,” vetting withdrawals case by case. Although such actions had scant legal footing, officials not only looked the other way, in many states they encouraged banks, for their own protection, to curtail teller operations. Bank holidays were proclaimed in a handful of states, with California’s enduring until late December. Small wonder that Andrew termed it “the most extensive and prolonged breakdown” of the credit system since the Civil War.

  Even though clearinghouse certificates provided a measure of relief, they were generally recognized only in their city of issue, which was a serious drawback. A New York banker lamented that “drafts on Philadelphia, Boston and other banks sent for collection are being returned on the plea that momentarily it is impossible to remit New York exchange. Each city issuing its own Clearing House certificates . . . builds a Chinese wall against other centres.” Through November and much of December, the United State monetary system devolved toward the polyglot moneys of the early nineteenth century, when itinerant peddlers did business with different moneys state to state and territory to territory.

  Money, in fact, traded at a premium. Those who needed cash were forced to write checks for more than 100 percent of the desired sum. Money lost its normal, fungible characteristic—it was worth more in one place than in another. Brokers placed ads offering to buy and sell currency at premiums, the size of which was in constant flux. Out-of-town exchange was often unavailable at any price.

  Even the suggestion that banks were short of cash frightened depositors—many of whom withdrew funds while they still could. In New York, there was a run on the rental of safe-deposit boxes. Nationwide, bank deposits plunged by $350 million, much of which ended up stashed in bedroom dressers and kitchen drawers.

  However, hoarding by individuals did not cause as much harm as hoarding by banks. As Secretary Cortelyou noted, “It is said that many of our people have hoarded money. This is undoubtedly true, but so have many of the banks.” Country banks pulled deposits from reserve cities; middle-tier banks in such cities yanked money from New York, Chicago, and St. Louis. Country bankers were not without reason for taking precautions. Some found their deposits at reserve city banks to be temporarily frozen. James E. Ferguson, a bank president in Temple, Texas, got a telegram from his reserve city bank announcing that it would not ship currency, because the reserve bank, in turn, had been frozen by New York. As Ferguson later told a congressional committee, “We were broke with a pocket full of money.” It did not take many such experiences for small-town bankers to start hoarding currency.

  Banks in San Antonio, Indianapoli
s, Wichita, and Portland bolstered their reserves to 35 percent of deposits, well above the 25 percent required. Banks in Galveston, Texas, went to 49 percent, a veritable fortress of financial redundancy, and a bank in Indiana bragged it had a cash reserve of 67 percent—a good portion of which, Vanderlip sourly surmised, had been pulled from vaults in New York. The surplus reserves represented, in effect, the banking system’s wasted resources. In contrast, New York banks at least tried to supply liquidity by assuming the loans of failing trusts—and in so doing, ran their reserves to well below the legal minimum.

  Charges and countercharges flew; the question of blame became impossible to untangle. Did country bankers needlessly hoard reserves, as Vanderlip believed, or did New York’s risk taking leave the country exposed? Each accusation was correct. And while many out-of-town banks thought only of stuffing their vaults, they had every right to protect their own institutions.

  The problem was that the system inspired a competition for reserves, so that much of the country’s banking capital, though substantial in the aggregate, was never put to use. Reserves were disaggregated bank by bank and city by city. This rendered them sterile. Warburg likened the system to a town without a fire department in which each family maintained a pail of water to quench blazes in its own house.

  The contrast with Europe could not have been starker. In the British system, the Bank of England performed the job of “leaning into the wind”—that is, lending funds when funds were otherwise scarce. Not coincidentally, Britain had not experienced a banking suspension since the time of the Napoleonic wars. America had been scorched by five severe banking crises, in addition to more than twenty lesser panics, in little more than a generation. As the writer Richard Timberlake put it, “All institutions had to run with the wind; none could lean into it.”