J.P. Morgan to the Rescue

By John Steele Gordon

On Thursday, October 24, 1907, the American financial system stood on the brink of collapse. The global economy had been growing quickly since the late 1890s, but interest rates had lately been rising, threatening further growth. Stock markets around the world had been faltering as the price of call money—loans used to finance stock purchases on margin—rose.

Then an attempt to corner the stock of the United Copper Company failed and banks that had loaned money to finance the corner were thought to be in trouble. Depositors began withdrawing money from these banks and the banks began calling in loans to handle the withdrawals. The Knickerbocker Trust Company, New York’s third largest trust company, suddenly closed its doors, leaving a line of depositors two blocks long out of luck. 

Panic swept Wall Street and liquidity vanished from the marketplace. It is the business of a central bank to function as a lender of last resort in such circumstances, taking the loan portfolios of banks as collateral and lending them money as needed to maintain liquidity. 

But the United States had no central bank and the federal government had few means at its disposal to deal with such a crisis. The secretary of the treasury, George Cortelyou, came to New York and deposited $5 million in banks there to shore them up. But by law, the government could only deposit government funds in national banks. It was the trust companies and state banks that were in trouble.

Cortelyou did the only thing he could. He went to the country’s most powerful banker, J. P. Morgan, and asked for help. Morgan knew what the problem was. “If people will keep their money in the banks,” he told reporters, “everything will be alright.” Getting the people to do that, of course, was the tricky bit.

The Trust Company of America had been hemorrhaging deposits but Morgan knew that it was basically sound. So he told Cortelyou to deposit $35 million in national banks and then instructed those banks to loan the money to the trust companies and state banks. The panic at the Trust Company of America ended. 

When the president of the stock exchange told Morgan that the exchange would have to suspend trading as call money could not be found even at an interest rate of 100 percent, Morgan flatly forbade the exchange to close and raised $27 million among the bankers to keep it open. He let it be known that anyone selling short would be “properly attended to.” Most speculators didn’t want to find out what that might mean.

He then convened a meeting of all the leading bankers at his newly completed library and told them to find a solution, while he played solitaire in his office. “Why don’t you tell them what to do, Mr. Morgan?” his librarian asked.

“I don’t know what to do myself,” Morgan replied with characteristic forthrightness, “but some time someone will come in with a plan that I know will work; and then I will tell them what to do.”

The bankers finally came up with a plan to settle accounts among themselves at the New York Clearing House with, in effect, IOUs, allowing them to use their large clearing house balances to make loans to threatened banks.

It had been a near-run thing but the panic subsided. The crisis had one positive outcome, however. The United States realized that it could no longer do without a central bank and, after six years of intricate political maneuvering, the Federal Reserve was born.