A Blog of the Global Justice Movement

Thursday, November 15, 2012

Let's Make a Deal, VII: The Bankers' Panic

No, that's the right title for the posting. The "Panic of 1907" was known as "the Bankers' Panic" since it hit the financial services industry first and hardest. Ironically, the problems had been signaled well in advance, but did not seem very pressing once the country came out of the Great Depression of 1893-1898.

What nobody took into consideration was the fact that the system was set up to fail. Given the ultra-concentration of financial power in the hands of a single man, financier J. P. Morgan, it only needed a little push to send it over the edge. Consequently, what should have been merely the routine elimination of a competitor in the ordinary course of cutthroat capitalist business mushroomed into a global financial panic.

The problems had been brewing since Andrew Jackson's "war" on the Second Bank of the United States. Some people thought that the problem of concentrated control over money and credit had been solved with the establishment of the National Bank system in 1863. Having covered the problems associated with that system in previous postings, we need only note that having an inelastic, debt-backed currency for consumers, farmers and small businessmen combined with an elastic, asset-backed money supply for rich industrialists, commercial interests and financiers was a deadly combination, as the Panics of 1873 and 1893 demonstrated. It was custom-designed to concentrate wealth in fewer and fewer hands, something that accelerated rapidly after 1893 when easy access to capital ownership for ordinary people virtually disappeared with the effective end of "free" land under the Homestead Act.

So, what happened?

The president of the Knickerbocker Bank and Trust, the third largest bank in New York City, decided he could make a lot of money by using the bank's (i.e., the depositors') funds to "corner" copper. Translation: he wanted to establish a position in the commodities market by purchasing enough futures contracts on credit that would enable him to dictate the market price of copper, a critical industrial material.

To make a very long and complex story short, he failed. When the news got out, depositors rushed to the bank to get their money. Even in ordinary circumstances a bank that is not a member of a central bank cannot meet immediate demands for all its deposits. Remember the scene in It's a Wonderful Life when "George" (Jimmy Stewart) explains to the savings and loan depositors that their money is invested in other people's houses and businesses, not piled up in the institution's vault? A bank has to be able to sell or "rediscount" its paper for immediate cash to pay out its depositors, and it can only do that if it has a buyer that can't refuse to purchase good loans — a central bank.

In the case of the Knickerbocker, the depositors' money was not only invested in the usual types of things, but a massive amount had been pledged as collateral for the futures contracts that the bank president had purchased on credit. Again, given a little time, he could have liquidated his speculative holdings and made good the loss out of his personal fortune . . . maybe . . . but he wasn't given the chance. He needed the money to meet depositors' demands now, or be forced to close the bank. He applied to J. P. Morgan for a short-term emergency loan to keep the bank open, on the grounds that the financial system in New York couldn't take the strain of a significant failure.

Morgan knew the Knickerbocker had good assets that would back up the emergency loan, if he chose to accept them at their fair value. Morgan, however, decided that this was the perfect opportunity to drive a competitor out of business. He refused the loan. To make matters worse (and to ensure that the Knickerbocker couldn't apply to other banks for emergency funds), Morgan cut the Knickerbocker off from clearinghouse privileges. This made it virtually impossible for the Knickerbocker to buy or (especially) sell securities to raise cash fast.

As Morgan expected, the Knickerbocker was forced to shut down. Morgan then sat back and waited for the dust to settle so he could pick up the Knickerbocker's assets for pennies on the dollar.

It didn't work out quite that way. The run on the Knickerbocker caused panic among depositors at other institutions. Keep in mind that a bank can't keep 100% reserves on hand sufficient to liquidate all its deposits. Reserves don't back the deposits. Demand deposits in a commercial bank are backed by the bank's promissory notes, not cash, while savings accounts are invested in other assets, not kept in cash. Ordinarily a bank keeps only enough cash on hand to meet its daily transactions demand.

Other banks started to shut down for lack of cash, too, and panic spread beyond New York City, across the U.S., and to Europe. Morgan then stepped in and started making emergency loans. When called to testify before Congress a few years later, Morgan denied that he had anything to do with causing the Panic on the grounds that no one man could have that much power, a demonstrably false assertion, as the evidence showed. Morgan's testimony, recorded in the Pujo Report of February 1913 on the concentration of control over money and credit, is a masterpiece of equivocation, misdirection, and "playing dumb" after having been caught with his hands in a rather large cookie jar. Ironically, "standard" history gives Morgan credit for saving the country from the situation he created.

The economy was once again in a shambles, and it was painfully evident that something would have to be done — but what?

#30#

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