“Every Crisis Begins with a Shock”

Panic then and now — the enduring legacy of 1907.

An interview with Robert F. Bruner, Dean, Darden Graduate School of Business Administration, University of Virginia

Last year, on the 100th anniversary of their book’s subject, Robert F. Bruner and Sean D. Carr published The Panic of 1907: Lessons Learned from the Market’s Perfect Storm (John Wiley & Sons). A year later, as we weather a far greater financial storm, the book’s lessons are more relevant than ever. From their analysis of one of the worst banking panics in U.S. history, when dozens of banks and trust companies failed, Bruner and Carr conclude that financial crises typically result from the convergence of certain elements into a “perfect storm.” The book is an engrossing read, featuring characters such as Augustus Heinze, the brash entrepreneur; Charles Barney, the tragic trust president; and, above all, J.P. Morgan, Wall Street’s indispensable man. Bruner, who is Dean and Distinguished Professor at the University of Virginia’s Darden Graduate School of Business Administration, recently talked to CFO about how much the crises of 1907 and 2008 have in common.

The Panic of 1907 began in October of that year, when Augustus and Otto Heinze attempted and failed to corner the stock of United Copper Co. But, just as our current financial crisis took at least a year to bloom, you say the same was true in 1907?

It’s a misconception to believe that financial panics and crises are due to just a panicky world of depositors and investors. A panic has to start with something. Every crisis has at its core a real economic shock — and the shock is unambiguous, costly, and surprising. The shock in the case of 1907 was the earthquake that devastated San Francisco in April 1906. That earthquake triggered insurance policies to be honored by companies around the world. It drew gold, which was the currency of the day, out of the major financial centers of the world to San Francisco, in order to pay for rebuilding the city.

The United States of the day was the equivalent of China or India today: it was the engine of growth for the world. When the earthquake hit, it merely amplified a demand for capital that had been growing for decades.

The flow of gold to the United States prompted European central banks to raise interest rates to draw gold back to their financial centers. The tug-of-war for capital was slowly being won by the Europeans. It created a liquidity crunch that by late 1906 was in full swing. In March 1907, the “silent crash” saw the market lose about 10 percent of its value in a couple of days. That was the turning point of sentiment.

Other events presaged the actual panic.

Yes. One was the difficulty New York City had in refinancing its bonds. Essentially, the city borrowed on a short-term basis to fund some of its capital and operating expenditures. But it withdrew a bond issue in June when it couldn’t sell bonds at what the city council believed were fair yields. The city sampled the market again in July, but again had no luck. By August, conditions were getting perilous. At that point J.P. Morgan stepped in as an adviser and underwriter. He convinced the city council to agree to some extra conditions and a slightly higher yield and was able to place the bond issue in Europe.

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