Banking Panic of 1907

How did it happen and what does it matter?

This article will be based on the information found in the following article, which is sourced directly from the FED: https://federalreserve.gov/pubs/feds/2013/201311/index.html#footnote_reference_2

Let’s set the stage. There have been 2 American federal banks, neither of which were anything like our modern FED. They acted more like accountants for the federal government rather than arbiters of monetary policy that we know now.

During the later half of the 19th century there were a series of bank failures. Throughout this time there was a rather ridiculous debate that focused on whether banks could put their reserves to work, which by definition makes them non-reserve assets.

Due to certain interbank regulations banks could pretty much double dip. What this means is that banks could declare cash deposited at other banks as their own reserves, this led to quick growth and quicker failures.

The Comptroller noted in 1900 that reserve rates should be increased to bring back stability to capital markets and the economy. This would have made it so that banks would be more solvent in trying economic times.

So what happened in 1907 is a textbook example of how banking should NOT be organized. Most of the reserves for the large banks were composed of call loans. Call loans are loans made to stock brokers to buy stocks, and the banks assumed that they would be able to easily sell and cover their loan.

What started the panic was a failure in cornering the copper market. Seems important, right? Nope. Not at all.

This created insolvencies and the there were runs on the banks that led to attempted liquidations of the bank reserves. Only problem is this put an immense amount of strain on the call loan market which quickly broke down.

Then because most of these banks had interbank deposits with and from other large banks throughout the country, the panic spread, and all large banks started to hoard cash for fear of a mass of withdrawals that would completely decimate their reserves.

The crisis ended when JP Morgan and others agreed to be the act as the lender of last resort. A path was quickly set for the creation of a central bank to “solve” these liquidity problems. The theory was that gold and treasury notes were not elastic enough to meet liquidity droughts. Enter the age of infinite money printing.

Some say that the FED was created to take power away from JP Morgan and his buddies, if that were true then then the FED wouldn’t be a private organization with private ownership.

Those in favor of a central bank soon created the Federal Reserve in 1913, but do not be mistaken. This update to our financial system did not “solve” any liquidity issues, rather it threw a massive bandaid on the problem. Increasing reserves ratios and stipulating what counted towards those reserves would have increased the security of the financial system.

What was done is simply remove the inherent rarity of money by creating an organization that can inject or remove any amount at any time to oil the places where the gears grind too loud. A look at the 2008 crisis is forthcoming and will very clearly demonstrate how the FED operates in liquidity crises.

Consider all of this when thinking about crypto. The root of $BTC is digital scarcity: the internet’s gold, that is where crypto started. Actually attempting to create real value backed by scarcity and a usecase.

Our current fiat system was broken from the start.