Bankers' panic of 1907 introduction

The subprime mortgage crisis brought US banking system to its knees at one point. Lehman Brothers, Fannie Mae and Freddie Mac were all huge shocks but following the FED and the United States government interventions, the confidence was eventually restored. This wasn't the first banking system crisis and probably it shall not be the last. In fact, just over hundred years ago there was a financial crisis similar to subprime mortgage crisis which actually led to the creation of the Federal Reserve System.

At the beginning of the 20th century, American economy was maintained by speculation and investments in merging and expanding corporations. The currency supply was expanded by new discoveries of gold in Alaska, South Africa, and Colorado, and from the use of new extraction and reclamation technologies.

Stock markets grew, businesses flourished. However, the currency supply was not expanding as quickly as the economy thus creating future problems. At the time life was full of opportunities.

Famous saying by President Roosevelt in the 1906 describes the state of mind perfectly as he said Americans were enjoying "a literally unprecedented prosperity". Ironically, one of the biggest crises of the decade came shortly; in 1907 the crisis occurred that we know today as Bankers Panic.

National banks, state banks and trust companies
So the speculation in the early 1900s was running wild. The lack of a central bank became a worry for many investors because the banks were heavily involved in the market, either as underwriters or investors themselves. There were three main types of financial intermediaries: national banks, state banks and trust companies. It is not surprising that trust companies were the central point of the panic.

They were administrators of trust funds, money invested on behalf of estates, wills, as well as providing a link to the markets for market speculators. By granting speculators loans and taking securities as collateral, if stocks fell the trust banks and their investors would be severely hurt. Without a central banking system, no one would loan them money if a depositor's run developed or they needed cash to prop up their positions. Why were they interesting then? Well, according to some researchers, in New York between 1890 and 1910 assets at the trust companies had grown around 244% during the 10 years ending in 1907, from $396.7 million to $1,394.0 million.

In contrast, national bank assets had grown 97%, from $915.2 million to $1,800.0 million, while state-chartered bank assets had grown 82%, from $297 million to $541.0 million. Obviously, the amount of trust funds assets had a strong influence on the New York money market. Trust funds were also much less regulated than national or state banks. In 1906 New York State instituted a requirement that trusts maintain reserves at 15 percent of deposits, but only 5 percent of deposits needed to be kept as currency in the vault. Before that time trusts simply kept whatever reserves they felt necessary to conduct business.

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