… the action of the Clearing House on Saturday and Sunday had eliminated practically all elements of danger from the banking situation.

—Wall Street Journal, October 22, 1907

Augustus Heinze’s abrupt resignation from the presidency of the Mercantile National Bank focused the attention of a wider audience—depositors—on the condition of the bank. As depositors fled with their money, the erosion of the Mercantile’s deposit base soon came to the attention of the New York Clearing House (NYCH). Founded in 1853 to simplify the settlement of payments among member banks, it had proved to be a source of systemic stability in times of panic. But how much stability it could provide depended on which of many kinds of financial institutions had joined the clearing house.

A Patchwork System

Unlike most European countries, the United States did not have a central bank or regulator to backstop its financial system in 1907. Ever since President Andrew Jackson had withdrawn the charter for the Bank of the United States in 1837, the prevailing political sentiment had reflected a distrust of the economic and political power of banking institutions and sought to promote a financial system consisting of small, widely dispersed banks. In 1907 various types of banks conducted business:

• National banks operated under charters issued by the federal government, had to conform to stricter capital and reserve requirements, submitted periodic reports of condition to the Comptroller of the Currency (CoC), and endured unannounced reviews by the CoC’s bank inspectors, in return for which they were authorized to receive federal deposits and issue government‐licensed currency. The 6,422 nationally chartered banks were generally more stable than the 15,564 non‐nationally chartered banks in the United States.¹
• State banks were typically smaller and localized institutions, chartered by state legislatures and subject to somewhat more lenient regulatory oversight. State‐chartered banks had proliferated widely in the United States since the Civil War, and by 1906 held 50 percent of all commercial bank assets.² Approximately 12,000 state banks formed the bulk of non‐nationally chartered banks.

National banks and state banks constituted the field of commercial banks, mobilizing deposits from individuals and firms for loans to businesses and individuals. In 1907, commercial banks were the main source of credit creation in the U.S. economy. On the periphery of the commercial banking industry in 1907 were a range of other institutions, which might be called “shadow banks” in the parlance of twenty‐first‐century finance:

• Mutual savings banks were usually smaller and localized institutions, chartered by states and owned by their depositors to serve more specific needs such as mortgage lending. At the end of the nineteenth century, savings bank assets averaged about a fifth of all commercial bank assets. In 1907 the United States tallied 625 such institutions, and total assets of $3.25 billion.³
• Private banks operated without a government charter because they served a private clientele rather than the public and did not issue banknotes (currency). These institutions ranged from international houses, such as J. P. Morgan & Company and Kuhn, Loeb & Company to immigrant bankers who ran their businesses out of grocery stores and saloons. Private banks, especially immigrant banks, provided a wide range of services to their customers besides checking accounts, such as savings accounts, loans, and currency exchange. Immigrant private banks also transferred money abroad, sold steamship and train tickets, read and wrote letters for illiterate or non‐English‐speaking customers, and helped people find jobs. In mid‐1907, the United States counted 2,784 private banks, which reported $565 million in assets.⁴ As a general rule, private banks were not members of the NYCH.
• Trust companies operated under state charters and less onerous regulations than commercial banks. Trust companies first appeared in the mid‐nineteenth century, grew slowly, and then surged in number after 1896. In 1906 the United States had 1,333 trust companies.⁵ In contrast to banks, trust companies tended to invest in longer‐term and less liquid assets, paid higher interest rates on deposits, and held lower reserves and more interest‐earning assets (92 percent versus 70 percent for national banks). But the trust companies provided fewer payment‐related services than banks and therefore had fewer clearings. The total value of New York City trust company assets had grown 2.5 times over the decade to $1.36 billion, close to the $1.8 billion of New York national banks.⁶

Fractional Reserves Create Tight Linkages

Federal and state regulators required banks to hold cash reserves against the likelihood of withdrawals by depositors—the amount was a fraction of all deposits, thus leading to the term “fractional reserve banking.” As a means of enhancing returns, many banks regularly placed part of their reserves on deposit with other financial institutions. Small rural “country banks” would send reserves up to a regional “reserve city” such as San Francisco, St. Louis, or Chicago in order to earn a higher rate of return than idle cash. And reserve city banks would send a portion of their reserves up to banks in the money center of the nation, New York City. The flow of reserves observed a pecking order from small to large, from interior to reserve city to New York, and from non‐national to nationally chartered institutions.

For instance, federal regulations required country banks to hold reserves equal to 15 percent of their deposits; 40 percent of these reserves had to be held in cash in the bank vault, but the balance could be placed on deposit at “reserve city” banks, where the reserves could earn interest. These reserve city banks had to hold a reserve equal to at least 25 percent of their deposits and half of those reserves in vault cash, with the other half typically placed on deposit with banks in New York.

A worrisome development was the mismatch between the rapid growth of bank deposits and the cash reserves available to meet depositors’ demands. The interbank deposits of non‐national banks and national banks almost quadrupled from 1896 to 1907.⁷ Reserves of the New York national banks from 1897 to 1907 generally exceeded the 25 percent minimum ratio to deposits. On the other hand, the reserves of the nationally chartered country banks plummeted over the decade, from 11.6 percent in 1897 to 7.5 percent in 1907.⁸

Another concern was that many of the banks in New York and other major financial cities were heavily involved in the securities markets, particularly in railroad underwritings or lending to speculators and brokers in the “call money” market. Call loans typically extended for short periods and were collateralized by the pledge of marketable securities. Therefore, a slump in securities prices could potentially prompt anxiety among bank depositors. If that anxiety precipitated runs, an abrupt systemwide contraction could result. Interior banks were thus tightly coupled to financial institutions and securities markets in the nation’s money centers, making them (and the system) vulnerable to a crisis. As the Panic of 1907 unfolded, the linkage among financial institutions created by fractional reserve banking would prove to be an important pathway for contagion. With tight linkage, trouble could travel.

Endemic Instability

Since the Depression of the 1890s, in which several hundred banks had failed, the American banking industry had regained its footing, although the failure of marginal institutions continued to haunt it. In 1903 there had been 52 bank failures or suspensions, but that number jumped to 125 failures in 1904, most of them by state or private banks. In 1905, 80 banks suspended, while in 1906 53 banks suspended, again most of them state banks.⁹ When a bank failed, its depositors were out of luck; there was no state or federal deposit insurance. While there was no central bank to give liquidity to the financial system in periods of strain, the policy of recent secretaries of the Treasury had been to shift gold and currency to different regions and deposit the funds in banks that would then relend the funds to debtors. Occasionally, the Treasury would make advance payments of principal and interest on government bonds as an alternative means of injecting liquidity into the financial system.

Throughout the nineteenth century, bankers and public officials had debated the efficacy of various private arrangements to quell banking panics. The First and Second Banks of the United States had been publicly chartered but were privately owned disciplinary guardians of prudential practice. After President Jackson’s veto of the Second Bank’s charter in 1832, the United States embarked on other private market experiments aimed at stabilizing the financial system. The Suffolk System in Massachusetts (1824 to 1858) functioned as a way for banks to mutually guarantee the soundness of the banknotes they offered to the public.

However, the most enduring of the private sector remedies was the clearing house. The first one was founded in New York City in 1853 as an association among 52 firms. The New York Clearing House (NYCH) afforded convenience as a place to settle daily balances among members. To join, a bank had to commit to a high standard of capital and specie reserve requirements, and to present a weekly statement of financial condition to all other members, thus addressing the information asymmetry about banking conditions that was fertile ground for a banking panic. Any bank that failed to settle at once what it owed other members would be immediately expelled. Thus, membership in the NYCH was a signal of stability and a commitment to prudential banking.

As the nineteenth century advanced with its many financial crises, the NYCH evolved into an institution for mutual support of members. Knowing the condition of a member bank might make it easier for the other members to assist that bank in times of distress. In the Panic of 1857, members of the New York Clearing House issued “loan certificates” to be used in lieu of cash and backed by assets held by each institution. The Clearing House Loan Certificate (CHLC) was a joint liability of all member banks.¹⁰ The pooling of risks among the members introduced the important concept of coinsurance as a means of forestalling crises.¹¹ In a bank panic, CHLCs could become “near money,” plausible substitutes for cash. In a financial crisis, it might make sense for the entire membership to suspend convertibility of deposits into specie and to settle balances among the banks by means of issuing clearing house loan certificates that would be backed by the entire clearing house membership—such collective action by the clearing house would signal that the inability to convert notes into specie was not an individual problem but rather a systemic problem.

And finally, the NYCH created beneficial network effects through the sharing of information among members. As the membership grew, the network effects strengthened. Notwithstanding these benefits, the exclusive character of the clearing house prompted some critics to accuse the NYCH of monopolizing the reserves in the financial center of the nation and using them to discipline competitors.¹² By 1906, the clearing house model had spread to many other cities in the United States.

In contrast to other banking centers, such as Chicago and St. Louis, the NYCH membership included almost no trust companies. In 1903, the bank members of the NYCH had offered affiliate membership to trust companies on condition that the trust companies adhered to reporting requirements and a reserve minimum of 10 percent of deposits—well below the reserve requirement of the New York banks. To be an affiliate meant that a trust company would clear payments through a bank member of the clearing house. As contemporary journalist Alexander Dana Noyes noted,

A controversy of much warmth broke out. During the discussion, such contemptuous terms were used, in public statements as “the foolish fetich of a cash reserve.” Banks were accused of trying to cripple trade competitors who had got ahead of them.¹³

Three trust companies agreed to these rules: the Knickerbocker Trust Company, the Van Norden Trust Company, and the Manhattan Trust Company. The other trust companies were loath to abandon the competitive advantage they held over the banks. Thus, in a fateful split in the New York financial community, trust companies turned their backs on the NYCH, creating an exclusion that would figure prominently as the Panic of 1907 unfolded.

Unfortunately, the deficiencies of the patchwork of private and public institutions were manifest. First, many contemporary critics charged that the currency of the United States was “inelastic,” meaning that the volume outstanding could not adjust easily to meet variations in economic cycles, bumper crops, or shocks. Second, no single regulatory agency monitored monetary conditions or the overall stability of the financial system as a basis for promoting disciplined lending. Third, there was no uniformity to clearing house organizations and practices; in some geographic areas, no clearing houses existed at all.

Run on the Mercantile: NYCH Responds

In the context of this complicated and fragile system, then, anxieties about the solvency of the Mercantile National Bank gripped uneasy depositors and investors alike, prompting a run on the bank. With nowhere else to turn, Augustus Heinze sought the assistance of the New York Clearing House (NYCH).

The NYCH, of which the Mercantile National was a member, convened on Thursday, October 17, 1907, to discuss the events of the past few days, specifically the Mercantile’s affairs and the activities related to United Copper. The NYCH announced it would stand by the Mercantile and see it through any troubles in the coming days—if the books were sound. The NYCH sent a committee directly to the Mercantile’s offices in the Western Union Building to review its books. The detailed review went late into the night while practically all the Mercantile’s staff remained on hand.¹⁴ As one of the bankers present expressed it, “We went through it like a dose of salts.”¹⁵ At midnight, the NYCH committee reported that the Mercantile’s capital was intact and that the bank would be open for business on Friday morning.¹⁶ In a statement, the NYCH said, “… the bank was perfectly solvent and able to meet all its indebtedness. The capital of $3,000,000 is intact and with a large surplus.”¹⁷ This assessment assumed, of course, that the run would cease.

The NYCH’s decision to aid the Mercantile, however, did not come without strings. A group of nine member banks each agreed to extend $200,000 to meet the Mercantile’s debit obligations at the NYCH. But, as a condition for assistance, the NYCH demanded the resignation of all directors of the Mercantile. This move was intended to calm depositors and to give a new bank president a free hand in reorganizing the bank’s management. The offer to Comptroller Ridgely was still outstanding after he had visited the Mercantile at midday.¹⁸ “The clearing house committee minimized consequent fears,” the Chicago Daily Tribune reported, “by declaring that the condition of the banks generally was satisfactory, though the qualification was made that in some instances changes in the directorates of other banks might be necessitated. It was insisted that there was nothing alarming in the local banking situation.”¹⁹ A representative of the NYCH said reassuringly, “The situation is now under control, and no untoward developments are looked for.”²⁰

Despite the actions and assurances of the NYCH, the intensity of the run on the Mercantile continued unabated, and fears of unforeseen runs on other banks were growing. On Saturday, October 19, the Mercantile showed another big debit balance in its account at the NYCH. The debit amounted to a stunning $1,137,000, indicating that depositors’ withdrawals were straining the bank’s reserves, which stood at $1,745,000, equal to only 15.4 percent of its deposits, far less than the 25 percent required by banking law and NYCH rules. More alarmingly, the Mercantile’s total debit balances at the NYCH over the previous three days had been $2,400,000, 20 percent of its total deposits. It was estimated that at this rate the bank’s debit balances would exhaust its deposits in 10 days. Other banks with connections to the Mercantile were showing even poorer reserve positions, between 4 and 5 percent. Notably, a few of the larger banks unaffiliated with Heinze interests showed heavy increases in their reserves, ranging between 29 and 40 percent, indicating that depositors were shifting their accounts to more well‐established institutions.²¹

At the opening of the business day on Saturday, October 19, the NYCH met again to consider the banking situation and the exigencies of the Mercantile. It was again agreed to make up the balance of any debits that the Mercantile was unable to pay, although the NYCH made no commitments to address further debit balances in the future. Frankly, the NYCH’s member banks did not intend to extend aid to Heinze’s Mercantile indefinitely. But as the day wore on, news for the Mercantile only worsened. First, the officers of the Mercantile informed several banks for which it had previously provided clearing services that it could no longer do so.²² Then, in the early afternoon, William Ridgely, Comptroller of the Currency, announced that he had refused the presidency of Mercantile National. Finally, the NYCH learned that the Heinzes’ loans from the Mercantile had reached a very large, but undisclosed, total.²³

Meanwhile, Augustus Heinze continued a public defense of his situation, issuing statements from his residence at the Waldorf Hotel, across the street from the offices of Otto Heinze & Company and the United Copper Company. He denied repeatedly that the clearing house was even assisting his bank, accusing its members of trying to profit from his difficulties, and he asserted his continued control of the Mercantile:

I have not sold a share of my stock and am still in control of the Mercantile Bank. The whole miserable situation is the result of the action of the Clearing House committee. Instead of coming out with a statement saying that the bank was entirely solvent, they made a lot of remarks about the impairment of surplus and started a run on the bank in the hope of attracting deposits to their institutions.²⁴

The NYCH, however, had by this time begun to turn its attentions to other banking institutions. It became clear that over the next two days the situation would extend beyond the Mercantile. Depositors were already beginning to withdraw funds from the banks owned by a man with close Heinze associations: Charles W. Morse.

On Saturday, October 19, the NYCH arranged for inspections of two banks controlled by Morse: the National Bank of North America and the New Amsterdam National. The National Bank of North America showed $15,011,600 in loans and $13,063,200 in deposits; its directors included such leading figures as William T. Havemeyer of the American Sugar Refining Company and Charles M. Schwab of U.S. Steel, as well as Charles W. Morse and Charles T. Barney. The New Amsterdam Bank had $4,447,400 in deposits and $4,495,600 in loans, and it was considered one of the most important of New York’s uptown banks. The NYCH committee conducted the inspections all day and worked until late in the night.²⁵

NYCH Defenestrates Heinze and Morse

By Sunday, October 20, the NYCH had decided to take its most drastic measure to date. It ordered the immediate elimination of Augustus Heinze and Charles W. Morse from all banking interests in New York City. The action was both swift and sweeping. Morse resigned from the National Bank of North America, of which he was a vice president and director; the New Amsterdam National Bank; the Garfield National Bank; the Fourteenth Street Bank; the New York Produce Exchange Bank; and two other financial institutions in his hometown of Bath, Maine.²⁶ Heinze, who had already stepped down from the Mercantile, was likewise removed from at least eight banks and two trust companies. The committee also insisted that Morse and Heinze had to repay their loans to their respective banks and further ruled that any evidence of “chain‐banking” would disqualify such banks or bankers from the NYCH. Thereupon, the NYCH announced its willingness to lend aid to any banks that had been under suspicion, having found them to be solvent. It was reported, however, that the Mercantile would undergo a process of slow liquidation.²⁷

On Monday, October 21, massive debit balances appeared at the NYCH for several Heinze and Morse banks. On that morning, the debits for Heinze’s Mercantile National Bank and Mechanics and Traders Bank were, respectively, $1,903,000 and $430,000; debits for Morse’s National Bank of North America and New Amsterdam National Bank were, respectively, $850,000 and $200,000. Altogether, the NYCH had disbursed $2.5 million in aid since the Mercantile’s troubles began; the balance for the ongoing deficits had been covered by the bank’s deposits or by calls on the banks’ outstanding loans.²⁸ The National Bank of North America, for instance, started the day with $1,400,000 in cash to meet the demands of its depositors. According to one report, “Large heaps of gold were piled up on the counter in full view of any depositors who entered the bank.” This bank repaid its debt at the NYCH from its own reserves and by collecting $1,750,000 from called loans.²⁹

Heinze’s personal troubles had, of course, only begun. Claims against his brother’s brokerage house were estimated to be $2 million,³⁰ and lawyers for Gross & Kleeberg and other Wall Street firms had filed a petition to declare involuntary bankruptcy for Otto Heinze & Company. At noon on Monday, the Heinze firm called a meeting of its creditors and issued a statement:

We regret to say that we find our affairs so much more than we had anticipated at first that we have been unable, with the greatest effort, to get them into shape to present them at the meeting called this day, and we are therefore obliged to ask you to meet us at a day later in the week, of which you will be duly notified.³¹

The New York Times reported, “the claims against Otto Heinze & Company alleged that the Heinzes made preferential payments to the Mercantile National Bank of $2 million to cover the personal debts of Arthur P. Heinze and F. Augustus Heinze. The filing further sought an injunction restraining the disposition of any further assets by the firm.”³²

The rapid intervention of the NYCH during the preceding days seemed to mitigate the likelihood of a full‐blown banking panic. Sounding an optimistic tone on the morning of Monday, October 21, the Wall Street Journal said that “the action of the Clearing House on Saturday and Sunday had eliminated practically all elements of danger from the banking situation.”³³ The interventions of the NYCH and the immediate consequences for Heinze and Morse should have been sufficient to restore public confidence. Now, scarcely a year after his triumph over Amalgamated Copper and Standard Oil, Augustus Heinze took substantial losses. And both he and Charles W. Morse had been ejected from positions of responsibility in the financial system.

Had Heinze and Morse been merely aggressive speculators, their personal reversals would have prompted no more than the passing interest of traders on the Curb. But investors and depositors understood the tight linkages among Heinze, Morse, and banking concerns throughout the nation’s financial capital. Their individual failures had already toppled two brokerages and had infected at least three national banks—all in the span of a week. But on Monday, October 21, the public would also learn that Charles T. Barney, the respectable president of the Knickerbocker Trust Company, was an associate of Charles Morse and Augustus Heinze, and that he might have been involved in their schemes. Should the Knickerbocker fall, its failure would signal to the public that something more endemic was threatening the financial system. By day’s end, widespread fear and uncertainty would spread like a brush fire.