The Panic of 1907, by Robert F. Bruner and Sean D. Carr – a book review

This is a case study of what the authors call “a perfect storm” in the financial markets. It is a highly readable historical account, and should be read by anyone who seeks to understand today’s global crisis. And we can a century later benefit from the lessons drawn from the panic of 1907.

The story features high drama – a failed attempt by speculators to corner the market for the stock of a copper mining corporation, classic bank runs and the failure of the Knickerbocker Trust Co., suicides of major personalities and investors, the Herculean efforts of J. P. Morgan to organize rescues of financial institutions considered solvent after ad hoc through-the-night audits, a near default by the city of New York, the efforts of the US Treasury to help ameliorate the crisis, and a key decision made by then President Theodore Roosevelt that on its face ran counter to his anti-trust sentiments.

The 1907 panic was relatively short-lived, and can be seen in retrospect as a footnote to the great “It,” the Great Depression of the 1930s. According to the authors, the financial crisis lasted 15 months – the duration, peak to trough, of the stock market price decline, or September 1906 to November 1907. The attendant recession was likewise brief. GDP fell sharply in 1908, but was back to pre-crisis levels in 1909.

The authors bill the 1907 episode as a “perfect storm,” a “convergence of large forces,” that had seven overlapping ingredients. Any other crisis might still qualify as one, but it may not have all these ingredients all at once.

What were these ingredients? Four of them are straight from the work of Hyman Minsky (a prior phase of economic growth, an inherent instability of the credit or banking system – labeled as “inadequate safety buffers” by the authors, undue fear and greed, and a “real economic shock” in the form of the San Francisco earthquake of 1906). The other three are: “system-like architecture,” which we may today label as “regulatory failure”; “adverse leadership”; and “failure of collective action.”

I have no problems with the Minsky-associated ingredients. By now, we recognize the Minsky model as the intellectual workhorse of economists who are not blind-sided by a futile search for highly mathematized and (presumably) precise macroeconomic models.

It also seems correct, in my view, to attribute a crisis to regulatory failure (academic economists today agree that there was a fatal lack of oversight over the OTC derivatives markets), or to a failure of collective action. The latter concept was developed by Mancur Olson to explain the under provision of public goods, and certainly, financial market stability is a public good.

What is perhaps new is the concept of adverse leadership as a cause of crisis. The authors define this concept in terms of “policies that raise uncertainty, which impairs confidence and elevates risk.” They point to that of Putin and Chavez of Russia and Venezuela, respectively, as contemporary examples of leadership that undermines respect for private capital. A similar charge was made by them against the anti-trust bent of then President Theodore Roosevelt. Ironically, the authors also considered that Roosevelt made an exception in early November 1908 in the case of the merger of US Steel with Tennessee Coal and Iron, which is said to have marked the beginning of the end of the 1907 crisis. What the authors seem to be saying is that today’s political leaders have to be extremely wary of how their pronouncements and actions may prolong rather than ameliorate the present global crisis.

In my view, the ingredient of “adverse leadership” cannot be distinguished from failure of collective action, unless the former is considered more for its “announcement” effects. But reaction to public pronouncements of leaders can also not be readily separated from “fear and greed” as elements of crisis. Perhaps the rubric of adverse leadership is there to emphasize the meaning of “adverse,” which in the authors’ minds seems to relate to a bias against private capital. But it is not the presence of private capital that is a “good” in itself, but rather its optimality, be it in terms of size or how it is deployed.

The book, published in June 2007, concludes that “It” “almost certainly” can happen again.

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