The Locked Library on Thirty-Sixth Street
Shadow Trust Companies and How J. P. Morgan Stopped the Run of 1907
Inside the red-silk West Room of his Renaissance marble library at East Thirty-Sixth Street and Madison Avenue in Manhattan, financier J. Pierpont Morgan sat alone at a card table playing solitaire across the first week of November 1907. In the adjoining bookrooms, two young bankers—Benjamin Strong of Bankers Trust and Willard Straight—crouched on Oriental rugs over ledgers hauled in by midnight messengers. Outside in the autumn rain, lines of depositors stretched four blocks down Fifth Avenue waiting to pull gold coin out of New York's trust companies. The United States had abolished its Second Bank in 1836 and possessed no central bank. As a result, the survival of the nation's payment grid rested entirely inside Morgan's private library.
The run of 1907 exposed a structural flaw in Gilded Age finance: the rise of an unregulated shadow banking system. Between 1897 and 1907, state-chartered New York trust companies grew nearly fourfold until their assets rivaled those of traditional national banks. Even so, they operated under completely different balance-sheet rules:
- * Regulatory reserve arbitrage: National banks were required by law to hold twenty-five percent of their deposits in hard cash reserves. New York trust companies were required to hold only five percent in vault cash while paying higher interest rates to lure away retail depositors.
- * Call-loan maturity mismatch: Originally chartered to manage quiet family estates, trust companies deployed their lightly reserved deposits into overnight stock-market call loans and speculative industrial syndicates. They also stood outside the protective umbrella of the New York Clearing House.
- * Contagion from a failed stock corner: On October 16, 1907, Montana copper promoter F. Augustus Heinze and speculator Charles W. Morse tried and failed to corner the shares of United Copper. When their brokerage house collapsed, depositors learned that Knickerbocker Trust president Charles T. Barney had funded Heinze's schemes.
When the National Bank of Commerce refused to clear checks for the Knickerbocker Trust on October 21, depositors pulled $8 million from Knickerbocker's marble headquarters at Fifth Avenue and Thirty-Fourth Street in three hours. The firm shut its doors before noon. Morgan immediately dispatched Strong to audit Knickerbocker's books, found its collateral impossible to value, and let it fail. By October 23, the run leaped downtown to Oakleigh Thorne's Trust Company of America at 37 Wall Street.
Morgan ordered Strong into the vaults of the Trust Company of America overnight to price every bond and stock certificate by hand. At 12:30 p.m. on October 23, Thorne's vault cash dropped to $180,000 while a crowd clamored on Wall Street. Strong hurried uptown and reported to Morgan that the trust company was still solvent. Morgan stubbed out his cigar and declared that the Trust Company of America was the exact line where the banking panic had to be stopped. He summoned the presidents of New York's clearinghouse banks to deliver $3 million in cash parcels within minutes. That afternoon, he also raised a $25 million call-loan pool to keep the New York Stock Exchange from shutting its doors.
Twelve days later, on November 2, a second crisis struck. The brokerage firm Moore & Schley faced bankruptcy over $25 million in loans backed by illiquid shares of the Tennessee Coal, Iron and Railroad Company. Its failure threatened to bring down the Lincoln Trust and the Trust Company of America at the start of the week. Morgan summoned over forty commercial bank and trust company presidents to his library on November 3. He placed the commercial bankers in the East Room and the trust company heads in the West Room. Then Morgan walked to the bronze front door, turned the key, and slid it into his coat pocket. He informed the trust company presidents that they had to sign a $25 million subscription to rescue their weaker peers while U.S. Steel bought Tennessee Coal. Otherwise, every bank in New York would collapse at dawn. At 4:45 a.m., the last president signed on the table. Realizing that the American financial system had survived only because one aging private banker held the keys to his library door, Congress convened the Aldrich Commission and created the Federal Reserve System in December 1913.