A Short History of Financial Panics in the United States
Financial Panics in the United States 1819-1914
Although the American economy experienced phenomenal growth and transformation during the 19th century, this record was punctuated by periodic contractions characterized by sharp price declines, paralysis of business, and widespread job losses. These historical episodes were known then (as they are now), as panics—so called because, at some point during the episodes (usually at their outset) contagious selling behavior on the part of the public precipitated self-reinforcing price declines in important asset classes, especially financial assets.
From the point of view of currency collecting, financial panics have had two general consequences. First, they increased the variety of banknotes extant, as old banks failed during the panics and new ones took their places. Second, they stimulated the issue of various emergency monies in the form of merchants’ scrip and other currency substitutes, all of which sought to accommodate the disruption that panics wreaked upon economic life.
While the details of each panic were different, central to each experience was the phenomenon of the bank run, whereby losses of confidence in the solvency of banks led their customers to rush to convert their financial claims into liquid form, often making insolvency a self-fulfilling prophecy. Given the importance of banks as sources of credit and a circulating medium, bank failures were the key ways that initial price shocks affected the wider economy.
As a matter of convention, historians recognize the Panics of 1819, 1837, 1857, 1873, 1893, and 1907 as having occurred in the United States during the century before Federal Reserve System existed. The year marks the onset of each panic, although their length and severity did vary. The following list does not include contractions of a briefer and shallower nature. The Panic of 1914 is included not because of the severity of its effects, but only because it involved some limited scrip emissions, along with the much larger issues of Aldrich-Vreeland emergency currency. Driven by severe external gold drains at the outbreak of World War I, the panic took place before the regulatory framework of the new Federal Reserve System was fully operational.
Panic of 1819
Rampant land speculation on the western frontier and the associated currency expansion were throttled by tighter policies imposed by the Second Bank of the United States, leading to widespread bank failures. External aggravating factors included a post-Napoleonic recovery in European grain production, a break in cotton prices due to competition from India, and a specie drain to cover bond payments on the Louisiana Purchase.
To read more about this episode, see:
- Crisis Chronicles: The Panic of 1819--America's First Great Economic Crisis (New York Federal Reserve).
- The Panic of 1819: America's First Great Depression (Museum of American Finance, pdf.)
Panic of 1837
As in 1819, land speculation and agricultural markets ran afoul of whipsawing domestic monetary politics (Andrew Jackson’s bank war, the contractionary Specie Circular, and his pet bank policies). Increasingly vulnerable in global markets as a commodity exporter, the United States imported the Bank of England’s higher interest rates to devastating effect. Low cotton prices bankrupted southern planters, while tight money led to a wave of bank closures, particularly in the east.
To read more about this episode, see:
1837: The Hard Times (Harvard Business School).
Panic of 1857
The monetary expansion prefiguring this panic came from increased supplies of California gold, although these years were also the heyday of wildcat banking under free banking laws at the state level. Unlike a generation earlier, the American economy had grown more interconnected and industrial, thanks especially to the telegraph and the proliferating railroad network. Bank lending to railroads, and the trading of railroad securities in the financial markets, provided opportunities for speculative overreach. An economic slowdown resulted in railroad bankruptcies that pressured financial values, leading to widespread bank failures.
To read more about this episode, see:
- Crisis Chronicles: Defensive Suspension and the Panic of 1857 (Federal Reserve Bank of New York)
- The Panic of 1857: Origins, Transmission, and Containment (Columbia University, pdf.)
Panic of 1873
As in 1857, overextension and collapse of multiple railroad lines were central features of this panic. Spending during the Civil War, and rebuilding in the aftermath, drew a flood of global investment into railroad securities, despite the county’s unstable postwar money politics, which were basically contractionary. The failure in September 1873 of Jay Cooke & Co, a major investment firm, shuttered the New York stock market and produced a cascade of bank failures and business bankruptcies. Even more so than in 1857, this panic and its grinding aftermath had a clear epicenter in the nation’s financial markets, as well as substantial international echoes.
To read more about this episode, see:
- Crisis Chronicles: The Long Depression and the Panic of 1873 (Federal Reserve Bank of New York).
- 1873: Off the Rails (Harvard Business School).
Panic of 1893
This complicated panic produced a long and painful business depression within the settings of an agrarian uprising that created uncertainty about the monetary standard (Populism), national political realignment (election of 1896), and violent labor-management relations (the Pullman Strike). International capital flight and the bankruptcies of the Philadelphia and Reading Railroad and National Cordage Company (followed by others) provoked a collapse in securities prices and widespread bank failures, especially in the west. Business paralysis and severe, prolonged unemployment were the results.
To read more about this episode, see:
- Crisis Chronicles: Gold, Deflation and the Panic of 1893. (Federal Reserve Bank of New York).
- The Depression of 1893 (EH.net)
Panic of 1907
Unlike earlier episodes, this panic arose more from the arrangement and dynamics of the New York financial market itself. A failed speculation in the copper market led to the collapse of the Knickerbocker Trust. Runs on that company spread to other institutions as the New York Clearing House and its member banks refused to offer support. Bank runs interacted with securities prices through the call loan market, funds for which were supplied by the pyramiding of bankers’ balances in central reserve cities, especially New York. As banks around the country tried to withdraw those balances, central reserve banks suspended payments, leading to a cascade of pre-emptive suspensions by banks across the country.
In its aftermath, the Panic of 1907 in particular energized the policy debate that led to the creation of the Federal Reserve System by 1913.
To read more about this episode and its aftermath, see:
- The Panic of 1907 (Federal Reserve History)
- United Copper, Wall Street, and the Panic of 1907 (Library of Congress).
- 1907: The Bankers' Panic (Harvard Business School).
- John Pierpont Morgan, Financier Extraordinaire (Library of Congress).
- Uncurrent Events: National Monetary Commission, 1909-1912 (FRASER).
- The Meeting at Jekyll Island (Federal Reserve History).
Panic of 1914
While not precipitated by some domestic event as were earlier episodes, the Panic of 1914 certainly belongs in any list of financial disruptions of the pre-Federal Reserve era. The short duration of this panic was due in no small part to the effective leadership of Treasury Secretary William G. McAdoo (plus ample supplies of government-issued Aldrich-Vreeland emergency currency).
The outbreak of World War I in late July 1914 threatened the American financial system with collapse. Mass selling of European positions on the New York stock exchange and the prospect of uncontrollable gold flows to Europe would have prostrated the New York financial markets, depressed the international exchange value of the U.S. dollar, and driven the United States off the gold standard. Domestically, nationwide bank suspensions, panic withdrawals, and cash hoarding by the public would have been likely consequences.
To prevent all this from happening, on July 31st Secretary McAdoo engineered the closing the New York stock exchange to stop further liquidations. In August he invoked the Aldrich-Vreeland Act to expand the supply of currency. Further, McAdoo organized the marketing of American cotton and wheat crops to Europe to generate the foreign exchange necessary to meet the country's maturing obligations to European creditors.
Together, these measures kept the United States on the gold standard, preserving the country's international credibility. Thanks to McAdoo's actions and supplies of Aldrich-Vreeland currency, banking system reserves were protected, thus avoiding any public panic. By the end of the year international pressure on the dollar eased to the point that gold exports ceased. In November 1914, the new Federal Reserve System finally opened for business The next month, the New York stock exchange was able to reopen.
To read more about this episode and its aftermath, see:
- When Washington Shut Down Wall Street (Museum of American Finance, pdf).
- The Fed's Formative Years, 1913-1929 (Federal Reserve History).
American Financial Exceptionalism
Certain basic features of the American financial system predisposed it to instability in the pre-Federal Reserve years. A federal political system made bank regulation a state-level responsibility, and stymied branch banking. Distrust of concentrated financial power made a central bank impossible to maintain and, after 1840, the Independent Treasury Act got the government out of the banking business. No single institution, whether public or private, stood ready to act as a lender of last resort to meet the financial system’s emergency liquidity needs. Finally, bankers, their regulators, and the public itself persistently distinguished between checkable deposits and currency, even though they were functional substitutes for one another.
From the point of view of currency history, financial panics in the United States can be divided into two general periods: the antebellum era (1819, 1837, 1857) and the National Banking era (1873, 1893, 1907). These two eras are broadly defined both by the prevailing type of circulating medium and the government policies that affected it.
Before the Civil War, the circulating medium consisted largely of privately-issued banknotes convertible into specie on demand. Absent any meaningful federal oversight (particularly after the demise of the Second Bank of the United States), state governments regulated but did not offer guarantees for the redemption of banknotes. Thus, in this era, a run on the bank happened when noteholders sought to convert their paper currency into specie (gold or silver). A bank that ran out of specie reserves to redeem its banknotes went bust, leaving its noteholders with paper currency that was potentially worthless.
After the Civil War, two changes—one policy, the other developmental—transformed the relationship between the circulating medium and financial panics. The first change involved placing the nation’s paper currency on a sustainably-safe basis. This happened through the issuance of greenbacks, a fiat currency backed by federal legal tender authority alone, and by the establishment of the National Banking System, which provided for a standardized, private banknote currency backed by federal government bonds. Thanks to these two new forms of currency, by the late 19th century paper money was essentially regarded as a safe financial asset whose value no one any longer questioned.
The second change came with the rising use of checkable deposits. While check-writing had been present in the antebellum era, checks became an increasingly common means of transacting business, in part precisely because of those policy reforms that had stabilized the value of paper currency. State-chartered banks, legally denied the privilege of issuing banknotes, could instead offer their customers the convenience of checking against their deposits. Even for national banks, as checks came into routine use, their currency-issuing privileges became a decreasing element of their operations and profitability. Indeed, many national banks curtailed their banknote circulations or issued none at all.
As a result of this transformation of the circulating medium, what a bank run meant also changed. Unlike the antebellum era, in the National Banking era a run on the bank happened when customers sought all at once to convert their deposits into paper currency (or specie). A bank that ran out of reserves to meet withdrawals was declared insolvent. As a result, depositors found themselves with claims upon their banks (in the form of deposit books and unwritten checks) that were potentially worthless.
At this point by the late 19th century, an obvious policy step would have been to backstop bank deposits in the same way that currency had been protected, in the form of deposit insurance. However, despite their functional equivalence, American law and practice distinguished clearly between hand-to-hand currency and checkable deposits. Paper currency, it was argued, deserved greater protection since it was not reasonable to expect every transactor to accurately assess the value of a given piece of currency. In contrast, a check drawn on a particular bank left ample scope for all parties to a transaction to exercise responsible judgment. In particular, it was commonly feared that deposit guarantees would give rise to moral hazard and adverse selection problems. Among bankers themselves, it was conventional wisdom that deposit insurance fostered unhealthy behaviors.
Absent any federal protection, a handful of states did experiment with deposit guaranty schemes in the early 20th century, beginning with Oklahoma in 1907. As a general matter in these populist and progressive states, small country banks were more favorably disposed towards deposit guaranty than their larger, urban counterparts.
Whether or not they favored deposit guaranty, in its absence bankers faced the continued problem of maintaining depositor confidence. In addition to meeting whatever prudential standards were set by state and federal authorities, banks banded together into private associations called clearing houses that not only facilitated the routine settlement of interbank debts but created some scope for collective governance and mutual aid, especially during crises. In particular, out of the clearing house experience emerged a distinctive form of emergency currency that became a salient feature of the Panics of 1893 and especially 1907: the clearinghouse certificate.
To read more about these 19th century banking and financial developments, see:
- Before the Fed: Historical Precedents of the Federal Reserve System, 1791-1913 (Federal Reserve History).
- Banking Panics of the Gilded Age, 1819-1913 (Federal Reserve History).
- Banking Panics in the U.S., 1873-1933 (EH.net).