Not-So-Lucky Sevens

by Beth Ann Bovino

The financial markets marked the centennial of the Great Panic of 1907 by holding another panic.  David Wyss, chief economist at Standard and Poors (and my boss) asked whether it’s an accident that these crises often seem to occur in years ending in ‘7’?  He said that “we had financial problems in 1957, 1967, 1987, 1997, and 2007. That it’s hard to tell about 1977 because the whole decade was one long crisis (maybe just having a “7” is bad).” Going back further, 1937 was a bad year, as were 1897, 1907, and, of course, 1917, with the start of America’s participation in World War I.

So, what is it about “7”?  There’s the "Lucky 7" dice roll (of course, roll it the wrong time at a craps table and everyone loses their money).  According to luckymojo.com, 7 is also said to be found on a lot of hoodoo curio packaging, including 7-day candles, and that Lady Luck wears dice for earnings which always show 7 (the Irish-American World War Two version).   It sounds like numerology. And, of course, 1929 negates the picture.  But it’s still pretty spooky.  Given today’s financial crisis, I wanted to learn more (about panics not numerology).

The Panic of 1907 was a financial crisis in the United States. The stock market fell almost 50% from its peak in 1906, the economy was in recession, and there were numerous runs on banks and trust companies because of a retraction of loans by some banks. It started in New York, but then spread across the nation and led to the closings of banks and businesses. While the 1907 panic was the fourth panic in 34 years, the significance of the 1907 Panic as an economic event went far beyond the usual ‘crash and recovery’ story.  The severity of the downturn was one of the major reasons for the founding of the Federal Reserve System, as Congress decided that the U.S. can’t depend on the good will and ability of private bankers to gets banks to cooperate in a time of crisis.

One book I recommend is The Panic of 1907: Lessons Learned from the Market's Perfect Storm, by Robert F. Bruner and Sean D. Carr. It is an academic study which analyzes the financial crisis that gave America the FDIC and the Federal Reserve. Seems pretty boring, right?  However, much of the book covers the events and personalities of the crisis, to make the account rival an episode from the T.V. show 24. The book begins with the earthquake of 1907.  It then follows the Heinze brothers’ failed effort, using borrowed money, to corner the copper market, which led to panic, the failure of banks and trusts and the impending bankruptcy of New York City. Add to this, J. Pierpont Morgan, the man who, superhero-style, was able to halt the spread of bank runs, though without a mask.

In their book, the authors point out the following disturbing similarities a hundred years later:  "War was fresh in mind. Immigration was fueling dramatic changes in society. New technologies were changing people’s everyday lives. Wall Street was wheeling and dealing...”  In the last chapter on theory, the authors describe which factors are required to develop a financial panic:  Buoyant Growth, Systemic Architecture, Inadequate Safety Buffers, Adverse Leadership, Real Economic Shock, Fear and Greed, Failure of Collective Action. They warned that many of these conditions are seen in 2007.  However, what was meant to be a warning, now describes what has just happened.

While the financial system has changed since 1907, the basic reliance on confidence remains. In addition, any long period of stability results in an underestimate of risk, which is followed by a sudden convulsion as risk perceptions return to more normal levels. When the market corrects, it usually overcorrects, at least temporarily.

The turmoil began in the subprime mortgage market, but has extended far beyond that to a general crisis of confidence. We are watching a classic run on the bank.  However, banks have been disintermediated by the short-term money markets, which have become a virtual bank. The central bank’s role in fighting bank runs has been well established, but needs to be extended to the money markets that now support the banking system.

This one will be likely to affect the economy less than in 1907 because the central banks have learned to handle liquidity squeezes better than in the past. We will have to see if Federal Reserve Chairman Ben Bernanke can do a better job than Mr. Morgan.

Bernanke and company seem to be trying.  Since August, the Fed has lowered interest rates by 100 basis points. They also announced the new Term Auction Facility on December 12th.  The measure is intended to provide liquidity to shore up markets that have been frozen by the current pressures in short-term lending markets.  Swap lines have been established to allow the transfer into other currencies… the coordination among the central banks seems like very good news, but the actual function of this auction facility remains unclear and markets remain skeptical.