The day $8 million was withdrawn in 3 hours

In October 1907, a run occurred on trust companies in New York. The trust companies were state-chartered, did not join the clearing house that was central to check clearing, and had cash reserves of around 5% of deposits (compared to 25% for national banks). On October 22, the third-largest, Knickerbocker Trust, paid out $8 million in three hours and suspended operations. The call money rate jumped from an annual rate of 9.5% to 70%, and to 100% two days later. On October 26, the clearing house decided to issue loan certificates (totaling $101.06 million) and simultaneously restricted the convertibility of deposits into cash. The Treasury deposited $36 million in banks between October 19 and 31, and $58 million in gold was imported in November. After two months of a premium on currency, cash payments resumed on January 1, 1908. The Aldrich–Vreeland Act of May 30, 1908, established the National Monetary Commission, and the Federal Reserve Act was passed on December 23, 1913.

The original question Without a central bank, who is the lender of last resort?

In the fall of 1907, queues formed at the windows of New York's trust companies. These companies operated under state charters and competed with banks for deposits, but they were not members of the check-clearing hub, the New York Clearing House. Citing their lower volume of clearings, they held cash reserves of only around 5% against deposits, a stark contrast to the 25% held by national banks. The lending of trust companies, which was half that of the city's national banks in 1890, had grown to the same scale by 1906. Trust companies provided uncollateralized daylight loans to stockbrokers, who would then repay them by taking out overnight call loans from national banks, using the stocks purchased that day as collateral. The trust companies were the initial providers of liquidity to the stock market.

On October 16, an attempt to corner the stock of the United Copper mining company failed, and depositors began to withdraw funds from banks associated with the schemers, Heinze and Morse. The Clearing House inspected its member banks, announced their solvency on October 20, and offered support on the condition that their management resign. The five associated member banks held deposits of $56 million as of October 12; member banks prepared a $10 million fund, and the situation was resolved by October 21. Sprague wrote that this copper speculation was an event that "would not ordinarily have possessed public importance" and noted that, up to that point, there had been nothing that could be called a crisis.

The crisis began with a non-member. On October 18, it was reported that the president of Knickerbocker Trust, the city's third-largest with $62 million in deposits, was an associate of Morse. On October 21, the National Bank of Commerce, which acted as its clearing agent, announced it would cease to do so from the next day. That same day, the Clearing House refused to lend to non-members, and J. P. Morgan also declined to provide support, stating that solvency could not be determined from Benjamin Strong's brief examination of the books. The board of directors dismissed the president. On Tuesday the 22nd, after paying out $8 million during a three-hour run, Knickerbocker suspended its operations.

The next day, the 23rd, the run turned to the Trust Company of America, the second-largest with $64 million in deposits. $12 million was withdrawn that day, $9 million the next, and $34 million over two weeks. From Thursday, queues also formed at Lincoln Trust. The call loan rate jumped from an annual 9.5% to 70% on the 22nd, and to 100% on the 24th, and there were times when no lenders could be found even at that rate. Morgan changed his mind, raising $25 million on the 24th and delivering it to the stock exchange's loan post, and raising another $10 million on the 25th. On the 23rd, a committee of five trust company presidents was formed. The trust companies handed over bonds they had pooled to national banks, which then used them as collateral to receive government deposits, circulating the funds day by day. On November 6, it was announced that a majority of both companies' shares had been placed under the committee's control and that financial arrangements had been made to continue operations, and the queues dispersed.

The Clearing House acted on Saturday, October 26. At noon that day, a Loan Committee was appointed, and issuance began using blank loan certificates that had been stored for emergencies. That same day, the Clearing House banks restricted cash payments on deposits and also stopped publishing statistics for individual banks. The president of the Clearing House later explained that they had postponed the issuance day by day because they knew it would halt cash payments nationwide, and only acted after reserves showed a deficit of $53 million. Sprague called the failure to issue certificates by Tuesday the most serious error of the crisis.

On Monday the 28th, clearing houses across the country followed suit. In 71 of the 145 cities with populations over 25,000, loan certificates or scrip were used, and in about two-thirds of these cities, cash payments were restricted. The governor of Nevada declared a bank holiday from the 24th, and the governor of Oregon from the 28th. In California, debt payments were suspended for over seven weeks, from October 31 to December 21. Clearing house certificates were issued in 50 cities out of 106 clearing houses, totaling $248.28 million, with $101.06 million in New York alone.

On October 31, a premium on cash appeared in New York. For two months, it cost more than one dollar in certified checks to obtain one dollar in cash, with the premium reaching a high of 4%. In that same month of November, over $63 million in gold was imported, even though the exchange rate was above the gold export point. Commodity exports swelled to $411.6 million in two months, and the bills of exchange for these exports drew in the gold. The Bank of England raised its bank rate to 7%. The premium disappeared on December 28, cash payments resumed on January 1, 1908, the last certificates were issued on January 30, and all were retired by March 28.

Deposits at trust companies fell by over 36% between August 22 and December 19, while deposits at national banks increased. Knickerbocker reopened in March 1908 with a $2.4 million capital increase. In 1908, industrial production fell by 17% and real GNP by 12%; the recovery took just over a year. On May 30, 1908, Congress passed the Aldrich-Vreeland Act, which provided for emergency currency backed by securities and established the National Monetary Commission. The Federal Reserve Act was passed on December 23, 1913.

It was cash that moved. The deposits of trust companies were payable on demand, and depositors could request cash at any time. With reserves around 5%, this meant that if 5% of deposits were withdrawn, their cash on hand would be exhausted. Banks could receive loan certificates from the clearing house and use them to settle clearing balances, thereby preserving their cash. Trust companies had neither this mechanism nor a mutual support organization. Although Knickerbocker was one of the companies that did not surrender its clearing privileges when the clearing house demanded increased reserves from trust companies in 1903, it was still a non-member.

The first to provide cash was the Treasury Department. On Thursday, October 24, $25 million was deposited in New York banks. Between October 19 and 31, $36 million was deposited, of which $30.7 million went to the six largest banks. Sprague calculated that half of the cash paid out by banks in the two weeks to November 2 came from the government. The net increase in government deposits from August to December was $72 million, and on December 3, the balance of public funds deposited in national banks was $223.11 million. The National Banking Act had no guidelines for panics, and the Treasury acted on the Secretary's discretion without explicit provisions. On November 19, it offered $50 million in 2% Panama bonds and $100 million in 3% certificates to serve as collateral for banknotes, but only $24.63 million in bonds and $15.44 million in certificates were accepted.

Next were clearing house certificates. Member banks deposited commercial paper and securities with a committee, received certificates, and used them to pay clearing balances. The certificates were a joint liability of all members, with an interest rate of 6%, and were backed by $453 million in collateral ($330 million in commercial paper and $123 million in securities). A total of $101.06 million was issued, with the outstanding balance peaking at $88.42 million, used by 32 of the 52 banks. In the last five days of October, 84% of clearing balances were settled with certificates, and in November, 96% were. The certificates did not circulate in the market but simply eliminated the need for cash transfers between banks. This allowed banks to increase their lending. Loans from clearing house banks increased by over $110 million in three weeks, taking over the call loans that trust companies and country banks had withdrawn.

Third was gold. In November, $58 million in gold arrived in New York, and in December, $38 million. Of the $90 million increase in gold from the end of August to the beginning of December, $70 million was from imports. The gold was not borrowed but came in exchange for bills of exchange obtained through increased exports. Fourth were cash substitutes. Clearing house checks, cashier's checks, and paychecks were printed in various places, amounting to $334 million on record, and Andrew estimated the total exceeded $500 million including unreported issues. In Pittsburgh, $47 million in paychecks in the form of $1 and $2 bills were issued. Most of these were privately issued notes prohibited by the National Banking Act, but they were not subject to the 10% tax on state banknotes, and no one was prosecuted.

Where did the cash go? Between August 22 and December 3, the cash held by national banks in New York City decreased by $43 million, while that of other national banks increased by $2 million. Combining government deposits, gold imports, and increased banknote issuance, at least $233 million in currency disappeared from the banks. In the four days from October 22 to 25, 789 safe deposit boxes were rented from 33 companies in the city, six times the normal rate. The safe deposit companies reported that the renters were not small depositors but businesses that paid wages in cash. Banks in the South and West hoarded more than twice their legal cash reserves; while banks in central reserve cities lost $58 million, country banks increased their holdings by $47 million. Finally, the price was paid by firms connected to trust companies. Small firms that shared directors with the hardest-hit trust companies saw their stock prices fall by 10.4 points and their investment rates drop by nearly half. This decline accounted for 18.4% of the $700 million decrease in corporate investment in 1908.

"Morgan single-handedly stopped the panic." Sprague writes that without Morgan's influence, no unified action would have been taken. However, the funds that stopped it did not come from a single person. They were bonds brought together by a committee of trust companies, government deposits secured against them, clearing house loan certificates, and gold brought in by export bills. Frydman et al. describe the rescue as "led by Morgan and partially financed by the Treasury," and Federal Reserve History, while calling the delivery of cash to the exchange a "legendary action," also writes about the roles of the clearing house and the Treasury.

"Morgan locked the bankers in his library and made them decide on the bailout." This scene, which also appears in NOMISMA's materials, does not appear in the historical sources cited here. Neither Sprague, Andrew, nor the Comptroller of the Currency mentions the library. Strouse (1999), Carosso (1987), and Bruner and Carr (2007), which Frydman et al. list as reading material, are considered the narrators, but those books are not included in the materials cited here. The origin of this scene is unknown.

"Heinze's attempt to corner the copper market was the cause." The failure of the corner was the trigger on October 16, and the clearing house had finished dealing with the involved member banks by the 21st. Sprague wrote that this speculation was "ordinarily of no public importance," and Frydman et al. used the fact that the trigger for the run was unrelated to the trust companies' corporate clients as a starting point for their research. Gorton and Tallman note that the start date of the panic itself is debated, with Wicker viewing the 22nd, when Knickerbocker suspended payments, as the start. Attributing the cause to a single speculation obscures the structural issue of trust companies with 5% reserves operating outside the clearing house.

"The government had no tools whatsoever to fight the fire." This is a sentence from NOMISMA's materials. There was no law providing guidance during a panic, and all privately issued banknotes were illegal. In that sense, there were no tools. However, the Treasury Department deposited $25 million in banks on October 24, $36 million during October, increased public funds by $72 million from August to December, and issued $150 million in securities on November 19. Federal Reserve History notes that the Treasury intervened based on the Secretary's discretion, not explicit statutes. From the perspective of the historical sources, it was not that there were no tools, but that there were no tools written into law.

"Knickerbocker failed and disappeared." Knickerbocker suspended operations but did not fail; it reopened in March 1908 with a $2.4 million capital increase and a reorganization plan by depositors and shareholders. Federal Reserve History notes that popular accounts contain this factual error. The Wall Street Journal reported in October 1908 that depositors at the 15 institutions (3 national banks, 8 state banks, 4 trust companies) that closed in New York and Brooklyn during the panic did not lose a single dollar.

"The Panic of 1907 created the Federal Reserve System." Federal Reserve History writes that this panic spurred the currency reform movement and made clearing house bankers recognize the value of a central bank. However, the path took six years: the act of 1908 established emergency currency issuance and an investigative commission, and the act of 1913 established the Reserve Banks. In his December 1907 report, the Comptroller of the Currency cited the lack of a central bank for currency issuance and reserves as the direct cause of the panic's nationwide spread. One cannot state definitively that a single panic created a single system.

Superlatives require a denominator. Federal Reserve History's "first global financial crisis of the 20th century" has the 20th century as its denominator. Andrew's "most extensive and prolonged breakdown of the credit mechanism since the establishment of the national banking system" has the period since 1863 as its denominator. Sprague's "larger gold imports than in any previous crisis" has the history of panics in the United States as its denominator. Of the 53 member banks of the clearing house, 4 disappeared from the roster during the crisis, and 2 were counted as failures.

The question that remains from this incident is that of what lies outside the lender of last resort. The clearing house inspected its member banks, acted as a single entity through loan certificates, and stopped the crisis for its members. The crisis was not stopped for the non-member trust companies, where deposits had accumulated on a scale similar to that of the national banks. Moen and Tallman compare the trust companies of 1907 to the shadow banks of 2007-09, writing that both crises began outside the center of the payments system. This is an interpretation, not an equation, and the same text notes the difference that Knickerbocker reopened after suspending operations, whereas Lehman Brothers failed.

Another point is how the crisis ended. Gorton and Tallman interpret that the clearing house concealed information about individual banks, instead publicizing only the surplus or deficit of the entire clearing house's reserves, and the premium on the market for certified checks became the price of the clearing house's own risk. The premium fell with gold imports and became zero in January 1908 when the inflow of reserves turned positive. In modern money courses, this structure is covered in chapters on "non-bank intermediaries," "borrowing short and lending long," "when banks fail," "reserve requirements," and "when the system nearly stops."

It can be compared to the 2007-09 Global Financial Crisis in that runs were directed at intermediaries outside the center of the payments system. The difference lies in the location of the mechanism. In 1907, it was the gold standard and private clearing houses; in 2007, it was the central bank and the securitization and repo markets. We do not compare the amount of the certificates with the amount of the Fed's lending facilities.

We do not compare it with Japan's asset bubble of the 1980s. The time scales are different: a multi-year rise in asset prices versus a multi-week bank run. We do not compare it with Madoff's fraud, as it is not a case of that type of deception. We do not compare it with Tulip mania, as there is no commonality in mechanism, with no banks or payments network involved. The panics of 1873 and 1893 were incidents where the same clearing houses responded with the same certificates, and Sprague and Gorton-Tallman compare them with 1907, but in NOMISMA's case files, only their names are on the register.