3 - 1907: The bank Panic

1) The background
2) The trigger
3) The symptom
4) The remedy
5) Similarities to 2008

The Panic of 1907 was a financial crisis that occurred in the United States when its stock market fell close to 50 percent from its peak the previous year. Panic occurred during a time of economic recession, when there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation, and many state and local banks and businesses entered into bankruptcy. Primary causes of the run included a retraction of market liquidity by a number of New York City banks, a loss of confidence among depositors, and the absence of a statutory lender of last resort.
The panic would have deepened if not for the intervention of financier J.P. Morgan, who pledged large sums of his own money, and convinced other New York bankers to do the same, to shore up the banking system. At the time, the United States did not have a central bank to inject liquidity back into the market.

The following year, Senator Nelson W. Aldrich established and chaired a commission to investigate the crisis and propose future solutions, leading to the creation of the Federal Reserve System.

1913 Fed Reserve was created. Banking changed from free banking to central banking.

Before 1913 we had a system which can very loosely be called “free banking and the gold standard.” There was no central bank, no lender of last resort, no federal deposit insurance. Banks issued currency as well as checking deposits, convertible into the precious metals. Bank note redemptions and the gold standard anchored the money supply. Excessive currency issuance was prevented. Money expanded and contracted with the needs of trade, not with the needs of government. Banks formed clearing-houses to settle balances and they lent on an inter-bank basis to temporarily illiquid but solvent institutions. - By Richard M. Salsman Banking Without the Too-Big-to-Fail Doctrine, Nov 1992.

The free banking era was not totally free, of course. Bank note issues were restricted by laws requiring currency to be backed by state or federal bonds—an indirect means of financing government. Branching was restricted as well, preventing full diversification. But the U.S. free banking era was more in line with a free market system of money and banking than our present era. As such, it should not be surprising that it produced relatively higher quality money and much safer banking.

Two past gigantic hardships and its two saviours

The Economist magazine wrote that: “…public credit depends on public confidence…The financial crisis in America is really a moral crisis, caused by the series of proofs …that the leading financiers who control banks, trust companies and industrial corporations are often imprudent, and not seldom dishonest. They have mismanaged…funds and used them freely for speculative purposes. Hence the alarm of depositors and a general collapse of credit…” The words appeared over 100 years agoon 2 November 1907 during the 1907 crash.
How telling are these words, are they foreshadowing something might occur 100 years later?