Panic on Wall Street: A brief history of fear

A century before the crisis of '07, there was the Great Panic of '07. What does history tell us? Fear is fanned by uncertainty, dubious values, confounding innovations and the lack of a towering leader. Sound familiar?

By Jerry Useem, Fortune contributing editor

(Fortune Magazine) -- If there's any reliable guide to market panics, it would be George Washington. Atop his granite pedestal, with its commanding view of the intersection of Broad and Wall streets, he has witnessed more than a century of financial mayhem. Being cast in bronze, he can't convey the lessons of history so directly. But chief among them is: Panics are precisely the moment you need someone of his stature (roughly 12 feet).

To be clear: A panic is not a crash but the critical point at which fear (or the awful apprehension of something) can produce horror (a "sickening realization," to borrow Devendra Varma's distinction). The outcome, as Washington would know, hinges on the will of a few to accept - if only to avoid collective ruin - the still scarier role of leader.

Black Thursday 1929: Crowds gathered near the stock exchange, under Washington's gaze.

There's a good body of evidence to support that conclusion. Andrew Jackson rid the nation of a central bank in 1836, which helped produce the Panic of 1837. An unforeseen effect of his policies - a host of barely regulated banks flooding the nation with paper money - produced bad results as well as some innovations: Reserve requirements could be met, for instance, by adding a layer of gold coins over a much bigger pile of tenpenny (or subprime) nails. No wonder banks chose Jacksonian $20 bills as our national ATM currency.

In 1857, panic got a technological boost. The failure of Ohio Life Insurance & Trust Co. would once have taken days or weeks to reach Wall Street. But the telegraph carried the contagion directly to the stock exchange and the economy at large. The incomplete nature of the news made it all the more alarming - the first time, but not the last, that technology fanned uncertainty.

If the Panic of 1873 has one timeless lesson, it's the physical inability of everyone to escape from trouble at the same moment. Jay Cooke, the railroad financier, had been stiffed by international lenders, and his bank (which then fronted the intersection of Wall and Broad) was suspending payments.

The New York Times described the scene: "The brokers stood perfectly thunderstruck for a moment." Then they "surged out of the Exchange, tumbling pell-mell over each other in the general confusion, and reached their respective offices in race-horse time.... The news of the panic spread in every direction down-town, and hundreds of people who had been carrying stocks in expectation of a rise, rushed into the offices of their brokers and left orders that their holdings should be immediately sold out.... Some of the men who were ruined swore, some of them wept." Forget about an orderly repricing of risk.

Which brings us to the Great Panic of '07, the drama - and trauma - that changed everything. It showed that you did need a man behind the curtain who could operate the levers in the Emerald City. Only he didn't have to be so small.

The directors of the Knickerbocker Trust thought they were being secretive when they met in a private dining room to discuss whether they should open their doors the next day, given its president's connection to a speculative copper scheme. They weren't secretive enough. According to Wall Street lore, they carelessly left the door ajar, and their conversation floated to the ears of a bystander and then, it seemed, to all 18,000 of its depositors.

Soon they were lining up at Knickerbocker's palatial new headquarters at 34th Street and Fifth Avenue. For several days Knickerbocker tried to buy time (one trick was for tellers to count and recount the cash very slowly). On Sunday, with the bank closed, attention shifted to a private library a few blocks away, where a flock of reporters waited outside to find out what exactly J.P. Morgan was thinking.

Though semiretired, Morgan was the closest thing America had to a central banker. In recent years he had become acutely concerned about liquidity - that is, the lack of a lender of last resort should the nation's banking system hit another scare. Among the sources of uncertainty were so-called trust companies like Knickerbocker, which operated like commercial banks but, like hedge funds, fell outside regulatory purview.

Inside his library that Sunday night, Morgan was organizing an emergency-response team of six bankers, including the young secretary of Morgan-affiliated Bankers Trust, Benjamin Strong. As Jean Strouse recounts in her biography, "Morgan," Strong was assigned to examine the books of troubled trusts to determine which were worth saving. Knickerbocker, they determined, was not, and it closed its doors. Depositors then turned on the next-weakest, the Trust Co. of America (TCA). Its ornate tower - finished earlier that year - was just doors from Morgan's office.

In TCA's offices, Ben Strong pored feverishly over its books. Shortly after 1 A.M., he walked the 30 paces to the corner, where he made a presentation to Morgan, who wordlessly waved away details to press the question, "Are they solvent?" Strong answered in the affirmative.

Morgan turned to the heavies assembled around him: "This is the place to stop the trouble, then." As TCA employees trudged into Morgan's offices with sacks of securities and collateral, $3 million of U.S. currency was being sent to TCA's offices. Salvation had arrived.

The aftermath in Washington was more of an aftershock. "Something has got to be done," announced Senator Nelson W. Aldrich. "We may not always have Pierpont Morgan with us to meet a banking crisis." Indeed, the next panic would hit in 1914, a year after Morgan's death. But by that time the U.S. had a Federal Reserve - and the foresight to close the stock exchange at the outbreak of war.

Before it became known as the Great Crash, it was, for a few days, the Panic of 1929. Weeks of volatility accelerated into a free fall on Black Thursday. Once again a rescue effort was organized by private bankers at the corner, who made conspicuous buys of blue-chip stocks, but its effects were short lived.

What followed was the even more devastating Black Tuesday, again exacerbated by the imperfections of technology (as would happen once more in 1987 when programmed stop orders triggered an automatic selloff).

The stock ticker, which could print only 268 characters per minute, fell several hours behind. Old quotes left an information vacuum that gave the cycle of uncertainty another vigorous turn. (Groucho Marx fell into such a depression that an understudy had to take his place for several shows in Broadway's Animal Crackers.)

Without a strong response from the Fed - whose chief voice, Benjamin Strong, had died the previous year - the market plunged into a chasm that would soon widen into the Great Depression.

Today the intersection of Wall and Broad looks in many ways as it did 100 years ago. Washington still holds his pose, while "Integrity," a giant work by the same sculptor, J.Q.A. Ward, still protects the works of man from its perch atop the stock exchange.

But the House of Morgan is now Downtown Living by Philippe Starck. Fronting the former Trust Co. of America is an oversized sign in Tiffany blue announcing the jeweler's imminent arrival at THE HEART OF WALL STREET. Cranes are busily converting the former Chase headquarters into condos. The rapid conversion of the area into an upscale neighborhood mirrors the intermingling of real estate and securities.

But it also underscores the kind of destabilizing forces that are the preconditions for crises: a nebulous concern about income disparities, assets obtained with easy credit, the use of novel financial instruments that seep into the mainstream, and above all, the lack of what Henry James called the "imagination of disaster."

If history holds one lesson, it's that we never learn from it, at least not enough. As for what the future holds - well, let's not speculate. The market has a way of punishing those who do.  Top of page