What is a Bank Panic ? -- Bank Panic Explained

Bank panic also known as Bank run are a series of unexpected cash withdrawals caused by a sudden decline in depositor confidence or fear that the bank will be closed by the chartering agency, i.e. many depositors withdraw cash almost simultaneously. Since the cash reserve a bank keeps on hand is only a small fraction of its deposits, a large number of withdrawals in a short period of time can deplete available cash and force the bank to close and possibly go out of business. a Bank run is an event in which many account holders at a bank withdraw all of their funds at the same time because they do not believe the bank is solvent. Ironically, the pressure of a bank run itself can cause the bank to become insolvent. In the United States, bank runs were fairly common before the creation of the FDIC, which insures bank deposits up to a certain amount. Example of Bank Panic is the Bank Panic of 1907 . The Bank Panic of 1907 occurred at the beginning of the twentieth century. It was the result of shrinking market liquidity and dwindling depositor confidence. In addition to this, there were plans to regulate trust companies. At the time, trust companies faced increased public scrutiny for adhering to less regulation than national or state banks. This skepticism triggered a run on the trust companies that continued to worsen even as banks stabilized. Without a central bank, leading financiers like J.P. Morgan stepped in and provided some vital liquidity. Even then, the Knickerbocker Trust Company—New York City's third-largest trust—was unable to withstand the run and failed in late October. This undermined the public's confidence in the financial industry and accelerated the ongoing bank runs. The Bank Panic of 1907 occurred during a six-week stretch, starting in October 1907. The trigger was bankruptcy of two minor brokerage firms. A failed attempt by F. Augustus Heinze and Charles Morse to buy up shares of a copper mining firm resulted in a run on banks associated with them. The New York Clearing House declared these banks solvent a few days later. By then, however, the contagion had spread to trust companies. The most prominent trust company to fall was Knickerbocker Trust, which was refused a loan by banking magnate JP Morgan. He did, however, provide a loan to the Trust Company of America—another financial institution targeted by depositors. Initially, the panic was centered in New York City but it eventually spread to other economic centers across America. It was ultimately quelled when the federal government provided over $30 million in aid, and leading financiers like J.P. Morgan and John D. Rockefeller continued orchestrating deals to bring confidence and liquidity back to the financial markets. The former especially played a pivotal role in handling the crisis. Working from his mansion on 34th Street, JP Morgan deployed his vast information network to mobilize and organize the rescue of major financial institutions. The panic's impact led to the eventual development of the Federal Reserve System. Today, the central bank operates under a dual mandate to maximize employment and stabilize inflation with monetary policy tools like open market transactions. At the time, the main difference between Europe and US banking systems was the absence of a central bank in the US. European countries were capable of injecting liquidity into the market during periods of financial distress. Many people felt a central bank system could have prevented the Bank Panic of 1907 by providing an extra source of liquid assets for financial institutions to tap into. This ultimately caused leading financiers to draft an early framework of monetary policy and reform in the banking system. That report was shelved until 1913 when then-President Woodrow Wilson signed the legislation into law. It created the Federal Reserve System with Charles Hamlin as the first chairman and Benjamin Strong—a key member of Morgan's company—as the president of the Federal Reserve Bank of New York. So What are the Parallels To the 2008 Financial Recession . The parallels between The Bank Panic of 1907 and 2008 Recession are striking. The recent financial crisis was centered around investment banks without direct access to the Federal Reserve System, whereas its predecessor spread from trust companies that existed beyond the New York Clearing House. In essence, both events started outside of traditional retail banking services but still ushered in distrust for the banking industry among the broader public. Both were also preceded by a time of excess in the U.S. economy. The Panic of 1907 was preceded by the Gilded Age during which monopolies like Standard Oil dominated the economy. Their growth led to the concentration of wealth among select individuals. Teddy Roosevelt referred to the "predatory man of wealth" in one of his speeches. Similarly, the period before the 2008 Recession was characterized by loose monetary policy and a growth in numbers at Wall Street. Tales of excess at banking and financial services institutions abounded as they raked in revenues after doling out dubious loans to Americans. The aftermath of the 1907 bank run led to the creation of the Federal Reserve while the recession prompted new reforms like Dodd-Frank. These mechanisms intended to protect the broader public from a financial meltdown and hinder the big banks from taking unreasonable risks.











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