JANUARY, 1908 FINANCE THE FINANCIAL PANIC IN THE UNITED STATES BY ALEXANDER D. NOYES THE narrative of American finance which closed with the last number of THE FORUM brought the story within a week or two of what soon turned out to be perhaps the most interesting juncture in the history of modern finance. Readers of the article published in this magazine three months ago would have obtained little or no premonition of exactly what happened within a month of its publication; precisely the same might in fact be said of the views publicly and privately expressed by the financial community as a whole. It is, indeed, correct in an unusual degree to say that the actual outbreak, this past October, of financial and commercial panic on a scale not approached in 1893, and scarcely paralleled in the famous crisis of 1873, took the whole financial world by surprise. To begin with, let us sum up the sequence of events in this remarkable episode. A well-known financier, asked by a friend in August whether we were likely to have a financial panic at New York this year, replied: "New York is in a panic Knickerbocker now." To a large extent this description was correct of the August market, and in retrospect it may be seen The Failure that the grave position in which some enormously wealthy capitalists found themselves at that time was in fact a forerunner of what was about to occur on the credit market as a whole. History will, however, set the beginning of the 1907 panic on October 22d, the day when the Knickerbocker Trust Company closed its doors; that wellremembered occasion was, in point of time, the date when the public Permission to republish articles is reserved. first showed signs of the sudden collapse of depositors' confidence which marked the series of troubled weeks which followed. Certain events of the preceding week had led up rather significantly to the Knickerbocker affair. A national bank in New York first had to appeal to the Clearing House Committee for assistance. This institution had become embarrassed through the reckless use of its resources by a group of speculators, who, as it happened, had also used in a similar way the resources of other affiliated banks under their own control. The Clearing House Committee, which is virtually an executive board of all the associated banks of New York City, found on examination that the Mercantile Bank was not insolvent, and that with some assistance its affairs could be tided over. No actual run resulted, therefore, from the incidents of that week. But, as usually occurs in an episode of this sort, these disclosures in one institution, at a time of general doubt and uncertainty, started the banking community as a whole to look into the status of other institutions. This is the process which in times gone by has invariably brought to light the weak spots of the situation, and such a point of danger was at once discovered in the Knickerbocker Trust's position. For numerous reasons, of which I shall have more to say later on, what was called the "trust company situation" had been for some years watched by experienced financiers as the probable storm centre in an actual financial crisis. The Knickerbocker Trust's directors, finding its resources seriously impaired, followed the Mercantile Bank's example and applied for help to the Clearing House Committee. Although not in any respect responsible for the regulation of the trust companies, the bankers spent a night session in examining the Knickerbocker's books. They found the company in a position of insolvency, where maintenance of payments, even with help from other institutions, was, in their view, impossible. Assistance was, therefore, reluctantly refused. These details, being made public in the morning papers, started an immediate run of depositors on the company. The company's doors were kept open for perhaps two hours, and in this connection are involved certain procedures which may be much more generally heard of when the whole incident is reviewed in calmer days. There were depositors, and large ones, who got their money out in advance of the general public, and before the institution closed its doors. I have spoken of the apprehension among thoughtful financiers that the New York trust companies would be the centre of disturbance when actual panic should break out in the united American market. Before, therefore, describing the incidents which followed the Knickerbocker failure, it will be necessary to explain just what this trust company situa The Trust tion was. Writing in THE FORUM of April, 1903, I described the controversy which had arisen that year between the banks of the New York Clearing House and the trust companies, whose checks had up to that time been exchanged and redeemed through the agency of banks in that institution. The Clearing House, after prolonged discussion, had unanimously adopted the rule that no such institution should be allowed to enjoy even the indirect use of the Clearing House for exchange of checks, unless it held in its own vaults 10 per cent. of its deposits in the form of cash. This requirement was afterward raised to 15 per cent. I mentioned at the time that the action of the Clearing House was based on the fact that the trust companies of New York City, though reporting $447,000,000 deposit liabilities, maintained against those liabilities virtually no cash reserve whatever. A situation of this sort, I pointed out, was "certain to be dangerous in a money crisis." The trust companies, in the somewhat angry dispute which followed, retorted that the substantial sum in cash deposited by the several trust companies in the banks was as available for reserve as actual cash in hand. THE FORUM cited at the time, the judgment of the financial community generally that this argument was fallacious in that it charged as a reserve, against a highly expanded mass of trust company liabilities, a bank deposit fund which was itself protected only by the 25 per cent. cash reserve of the banking law. That is to say, even if the trust companies safeguarded their own $447,000,000 deposits by a credit of $100,000,000 at the banks, the actual cash held against the entire liability was the $25,000,000 or thereabouts which the banks maintained against the deposits of trust companies with them. Clearly, this meant that the trust company deposits were sustained by the very inadequate cash reserve of not quite 6 per cent. How this situation came about is now sufficiently well known. The trust companies, originally incorporated under an act of New York State which contemplated only the doing of an ordinary trustee or administrator business for estates, minors, lunatics, and so on, had found means, through their own construction of certain general powers in the act, of entering on another field-that of deposit banking, pure and simple. Instead, therefore, of confining their activities to accounts such as would be left in the hands of an individual trustee, they not only accepted but solicited deposits of all sorts, even in small amounts, using the moneys thus obtained for investment in certain directions which were permitted by the original trust company act, but prohibited, for very wise reasons, in the State and national banking acts. They were able to use these deposits for investment in stocks and bonds, in syndicate operations, even in real estate and real estate mortgages, which are forbidden as investments for bank deposits on the ground, made plain by all experience, that where an institution is subject to instantaneous call for return of its deposits to their owners, it is not safe to place them in fixed investments where time would be required to reconvert the investments into cash. While, therefore, the field for investment of trust company deposits was thus left without ordinary banking safeguards, there was lacking also any provision for maintenance of reserves. Had the law contemplated this acceptance of ordinary bank deposits by the trust companies, while allowing the use of those deposits for investments of the sort described, it would undoubtedly have required a ratio of cash reserves on hand not only equal to that exacted from the banks, but very much greater on account of the greater risk involved in case of a run of depositors. This was the basis on which the Clearing House acted in its demands upon the trust companies, and, in the light of last October's experiences, no one is likely now to deny that the Clearing House banks were most moderate in their demands. But the trust companies did not think so. Some of them, which had continued to restrict their business to the simple trustee operations contemplated by the law, were merely angry at the idea of dictation by the banks; others including, naturally, all which had gone on an extensive scale into deposit banking of the ordinary sort-had to find some other excuse. Some of them alleged at the time that a run on a trust company was unthinkable; others cited the remarks of the president of one of the companies, which referred to the "foolish fetich of a cash reserve." In the end practically all of the trust companies withdrew from their Clearing House connections rather than accept the terms laid down by the banks for such facilities. This point is important; it has, as we shall see, an essential bearing on certain phenomena of the panic. The controversy, however, did not end here; in 1906 the so-called Wainwright Act was passed at Albany, requiring all trust companies to keep in reserve 15 per cent. of their deposits, of which reserve one-third at least must be in cash, while another one-third might be invested in State or municipal bonds and the rest kept on deposit with other banks or trust companies. As regards this Wainwright Act, it need only be remarked that no competent observer at the time thought it met the needs of the situation. What was needed was a cash reserve, against ordinary demand deposits, at least as large as that maintained by banks. This was clearly not achieved by the Wainwright law, while as for the stipulation that one-third of this meagre reserve might be kept on deposit not only with banks but with other trust companies, the panic was destined to disclose the fact that this was a path to immeasurable abuses. Human nature being what it is, one can hardly wonder that certain adroit and unscrupulous trust company officers should have utilized this clause for deposit of reserves by "swapping" such deposits with one another. That is to say, Trust Company A would give its check for a million dollars to Trust Company B and count that deposit as part of its required reserve, while Trust Company B would place an exactly similar sum with Trust Company A, and reckon it similarly as its own reserve. Clearly, this was no protection at all, and certain events of the panic week proved clearly not only that this evasion of the law had occurred, but that the mischievous results which might have been expected from it had actually come about. Beginning of the Run The reader will pardon this long digression; it is essential to the plain understanding of the narrative which is to follow. On the morning after the Knickerbocker failure of October 22d there was reason, in the light of all experience, to anticipate a run on the other trust companies. This run, as it happened, was directed toward the Trust Company of America, through a quite inexcusable series of headlines in a usually conservative morning newspaper, which announced in large capitals that the company was in danger but would be rescued. Considering that exactly the same statement had been made with regard to the Knickerbocker, it may well be imagined how slight the reassuring influence of this second newspaper proclamation on the public mind could be. The run began at once that morning; before the day was over it was plain to every one that perhaps the most formidable run of depositors in the history of banking was in progress. The Trust Company of America had no less than 15,000 individual depositors; the Lincoln Trust Company, to which the run at once extended, had something like 7,000. Many of these depositors had small accounts subject to instantaneous withdrawal; they had been attracted to these two companies through the high interest rate paid for their deposits-a rate made possible through the wide field for investment open to the use of these funds by the companies, under the lax provisions of the trust company act. Here, then, was the situation: With more individual depositors than the average savings bank would number, with deposits largely placed in fields of investment where quick conversion into |