Wednesday, March 19, 2008

Random Musing: Parallels To The Panic Of 1907

Notice: The Random Musing is meant to amuse, pique curiosity, and add a bit of controversy by looking at issue from a completely different perspective. If you emote after reading the Random Musing, then it is working.
I just happened to be reading about the Panic of 1907 when I noticed three very striking parallels to what happened in 1907 and what is happening now. They say that history doesn’t repeat itself but comes back in a similar form. I guess this is true since it seems that the issues that rocked the financial industry and the nation in 1907 is back again, this time in a slightly different guise.

What happened in 1907?
Here is an excerpt from the Wikipedia on the subject [bold and italics added for emphasis]:

“The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis in the United States. The stock market fell nearly 50% from its peak in 1906, the economy was in recession, and there were numerous runs on banks and trust companies. Its primary cause was a retraction of loans by some banks that began in New York and soon spread across the nation, leading to the closings of banks and businesses.

In March 1907, over-expansion and poor speculation led to a stock market crash. Money became extremely tight. A second crash occurred in October 1907. On October 21, the National Bank of Commerce ceased to honor checks of Knickerbocker Trust, causing a run on the Knickerbocker Trust. By the end of October 22, the National Bank of North America had failed and runs were sparked on nearly every trust in New York.

To bring relief to the situation, United States Secretary of the Treasury George B. Cortelyou earmarked $35 million of Federal money to quell the storm. Complete ruin of the national economy was averted when J.P. Morgan stepped in to meet the crisis. Morgan organized a team of bank and trust executives. The team redirected money between banks, secured further international lines of credit, and bought plummeting stocks of healthy corporations. Within a few weeks the panic passed, with only minimal effects on the country.

By February 1908, confidence in the economy was restored.”

What grabbed my attention immediately was the fact that the original J. P. Morgan was the one who came to the rescue, with the full cooperation and involvement of the United States Secretary of the Treasury George B. Cortelyou. How eerie is this? Compare this with the New York Times report on the Bear Stearns Bailout:

“Hoping to avoid a systemic meltdown in financial markets, the Federal Reserve on Sunday approved a $30 billion credit line to engineer the takeover of Bear Stearns and announced an open-ended lending program for the biggest investment firms on Wall Street.

After a weekend of intense negotiations, the Federal Reserve approved a $30 billion credit line to help JPMorgan Chase acquire Bear Stearns, one of the biggest firms on Wall Street, which had been teetering near collapse because of its deepening losses in the mortgage market.”

The other parallel is the complete lack of confidence in the counterparty that shook the stock market as noted in EH.Net Encyclopedia [bold and italics added for emphasis]:

“Meanwhile, by Thursday, October 24, call money on the New York Stock Exchange was nearly unobtainable. Call money was money lent for the purchase of stock equity, with the stock itself serving as collateral for the loans. Call loans could be called in at any time. The opening rate for call money was 6 percent, but exchange president Ransom H. Thomas noticed a serious scarcity of money. At one point that morning a bid of 60 percent went out for call money. Yet, even at that exorbitant rate, no money was offered. The last recorded transaction of the day was at the opening rate of 6 percent. Fearing a total collapse of the stock market, Thomas called Stillman for aid. Stillman referred Thomas to Morgan, who was in control of most of the available funds. While Thomas traveled to Morgan's office, the call money rate on the exchange reached 100 percent.”

Now, for the final parallel, the one that most people would say is IRONIC:

“In 1913, the commission recommended the adoption of the Federal Reserve Act, which mandated the creation of a central banking system to dampen the effects of future panics.”

I guess we came around a full circle. Now, after nearly 100 years, the report card for the Federal Reserve can be handed out. I will not be the one to grade them but I can guess what the final grades is going to be; and it ain’t going to be pretty…it most likely will rhyme with sail, mail, dale, pail…

May Your Trading Be Profitable

Ed Kim
DISCLOSURE: The author holds long positions in JPM at this time.

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