Understanding the Bank Panic of 1907
Consumer action is the main determining factor on how the economy fares in any given time. While actions from the government and different industries could influence the way consumers think and eventually act, they are still at the mercy on how consumers will interpret the information. This is the reason why economists, business experts and financial analysts should not only look at the events because of the data they receive. Experts should also look at how consumers react to the news and data they receive. Every economic action is nothing without the direct input of consumers. Industries have to harness these reactions to their advantage.
One of the clearest examples on how consumers drive the economy solely based on their perception is the Bank Panic of 1907. This early 20th century economic downturn comes with a variety of factors that ultimately led to the panic. However, the problem ultimately rose when consumers reaction to the news they receive have been so massive and unified that it practically broke the system. It’s a good example how perception can ultimately cause economic problems when they are never addressed fast.
Background on 1907 Bank Panic
The Panic of 1907 is not just a single event that happened out of the blue. It was built on a background that became one of the many factors that triggered the panic. At the start of the 20th century, the US Government is adapting a National Banking System. The system was established in 1863 and part of its purpose was to help finance wars and create a unified currency.
However, this setting comes with a big problem. The system is highly reliable on the available funds on treasuries. Banks literally have to withdraw loans when the funds are lowered. The setting has created fluctuations in liquidity which is very dangerous because it will ultimately rely on the success of a venture. In the early 20th century, farming is the biggest factor in liquidity as loans will increase in a specific season for farming.
Relying on available funds with fluctuating liquidity easily created a shortage of funds when the demands are too high. Banks will look for other banks for a loan but it will ultimately end somewhere because of the lack of available treasuries to back the funds. If there are no funds available for loans, it will cause concerns on consumers as they will think that their deposits are no longer in the bank.
Chain of Events Leading to Bank Panic
There are different factors that triggered the Bank Panic of 1907 but none of these factors have been bigger than F. Augustus Heinze. He is referred to as one of the “Copper Kings” but eventually sold his business in becoming a banker. In becoming a banker, he was able to work with different state and national banks. After he sold his business, he has more than $10.5 million which allowed him to work on the finance industry.
His experience with copper persuaded him to corner the copper industry which will ultimately give him and his business partners a monopoly on copper. This can be done by aggressively taking over the majority of shares from United Copper. But in order to do that, he will require a large sum of money. This was made available through loans from different banks. Banks allowed this loan because of the reputation of F. Augustus Heinze. With the help of F. Augustus Heinze’s brother Otto, they started their aggressive trading for United Copper October 1907. Because of the perception on future monopoly of copper through United Copper, shares reached to $60. But the aggressive movement failed because there are other shares available other than the Heinze Brothers. Short sellers started offering United Copper shares because they know they will earn big once the takeover is a success. With a failed takeover, the shares dropped to $10 in just two days.
The loans made by F. Augustus Heinze to different state and national banks are no secret in relation to aggressive takeover. When the shares dropped to $10, depositors perceived that the banks will never recoup the money they invested. This started the panic as people took out their deposits that the bank. The phenomenon where depositors panicked to take out their funds from the bank is referred to as “bank run”. Different banks around the country were liquidated because of bank runs.
Finding a Solution
The Bank Run in 1907 was mainly due to the depositors’ lack of confidence on banks. Because of the failed venture of banks through Heinze, depositors do not have the confidence that their banks will continue to exist so they have to take out their deposits as soon as possible.
The solution came from the government side and private efforts. The government pledged $30 million to aid different banks that are having trouble with their finances. Aside from the government input, J.P. Morgan persuaded other bankers and even foreign investors to aid banks and use their funds their funds to jump start the banking setting.
Effects of Bank Panic of 1907
The Bank Panic of 1907 eventually led to the creation of the Federal Reserve System. Before of the Federal Reserve System, banks have to rely on each other for loans which ultimately caused problems during the crises. By setting up a Federal Reserve System, the crises of 1907 will never happen again because banks will have more help in case of financial crisis.