The Last Uncontrolled Panic and the Trillion-Dollar National Debt

On this day in economic and business history...

The national debt of the United States was measured in billions for most of the country's history, until Oct. 22, 1981, when routine Treasury transactions pushed the debt above the not-at-all-routine $1 trillion level.

The U.S. government only managed to zero out its debts once -- in 1835, during the debt-fearing administration of President Andrew Jackson. But by the middle of the Civil War the government's debts soared past $1 billion as the Union threw all its resources toward victory. By 1974 the national debt had reached $500 billion, and it took a mere seven years of increasingly high deficit-spending to add $500 billion more. "If we as a nation needed a warning," President Ronald Reagan said of the 13-figure debt, "let this be it." However, by the end of his second term the national debt had more than doubled.

Due to the ratcheting-up of already high interest rates, the U.S. government expected to spend about $100 billion on interest payments for the 1982 fiscal year. Three decades later, despite a 16-fold increase in the national debt, interest payments had increased only fourfold. The national debt remains a huge political issue. Unfortunately, solutions are far harder to find than talking points, and meaningful reduction seems impossible to enact without causing significant economic pain.

A panic takes hold
The Knickerbocker Trust, a large New York trust institution, became a Lehman Brothers of turn-of-the-century Wall Street when it failed on Oct. 22, 1907. The trust became insolvent after a run of depositors removed $8 million from its coffers in a single morning. The Panic of 1907, as it's now known, was already rolling past the point of no return after two Wall Street insiders failed spectacularly in their efforts to create a short squeeze in the stock of United Copper. However, the collapse of Knickerbocker was the first major bank failure that resulted from this scheme, and the tightly bound world of Wall Street banks threatened to tip over into oblivion.

The Dow Jones Industrial Average (DJINDICES: ^DJI  ) , which had been in gradual decline since the start of 1906, had begun to plunge in winter 1907 as investors awakened to the realities of a weakening economy. By the following summer, the market was in full-fledged bear territory in response to an increasingly militant antitrust crusade marching forth from President Theodore Roosevelt's White House. When a federal judge fined Standard Oil a record-breaking $29 million for anticompetitive activities that August, the market began to waver. Standard Oil's shares, which were largely beyond reach of the investing public, fell by 16% over the following week. Market watchers began to see catastrophe ahead, and Standard Oil founder John D. Rockefeller warned his son to "be prepared for very disastrous results to our commercial fabric" should the crusade continue.

By the standards of most financial panics, this one had a light touch on the Dow. From the start of October to Knickerbocker's collapse, the index lost only 13%. But fear was palpable on Wall Street, which had no central bank to fall back on for emergency liquidity in the event of a widespread run on banks -- not that any central bank might have proven particularly effective, as the gold standard then in place severely constrained the short-term flexibility of the nation's monetary supply. News broke of Knickerbocker's precarious state the day before its run, which was, according to The New York Times, considered "so important that a separate meeting of Presidents of many of these big institutions was held ... last night." These big institutions were led by the bank of J. P. Morgan, who decided against supporting the ailing Knickerbocker and thus precipitated a run. The run lasted all of three hours on Oct. 22 before the trust's coffers were exhausted and it was forced to close.

The collapse of Knickerbocker, unlike that of Lehman Brothers a century later, did not push the markets into immediate or sustained free fall. The Dow fell a rather modest 2.8% on the day of the run, and only lost another 1.5% the following day. By this point, however, the Dow had already lost 43% of its value from the 1906 peak. By comparison, the Dow lost more than 4% of its value on the day of the Lehman collapse but was only just barely into a bear market at the time.

It did not help that the Times singled out Knickerbocker's rival, the Trust Company of America (the nation's second-largest trust), as a new "sore point." This brought similar pressure to bear on Trust Company of America the following day, forcing J. P. Morgan himself to swing into action. By the close of business on Oct. 23, he had funneled $3 million into that trust -- enough to keep it open the following day.

Oct. 24 became another major flashpoint of the panic. Morgan's masterstroke was already in motion that day: Treasury Secretary George Cortelyou disbursed some $25 million in "bailout" funds to the largest banks, which was the majority of his department's gold-constrained working capital, and Rockefeller, whose legal troubles had sped the decline, publicly pledged up to $40 million of his own money to help stem the panic. However, margin-supporting call money had dried up on the stock exchange as a result of the runs, which threatened assets all across Wall Street, as a lack of this short-term liquidity hindered most trades and suppressed share prices. Morgan would have to step in again, as NPR's All Things Considered recounts:

Around 1:30 p.m., Ransom H. Thomas, the president of New York's Stock Exchange, and one of his assistants came over to the Corner in a state of great excitement. When he arrived, the offices of J. P. Morgan & Company were full of other agitated men, but Thomas rushed up to the financier and said, "Mr. Morgan, we will have to close the Stock Exchange." Morgan turned to him and asked sharply, "What?" Thomas repeated, "We will have to close the Stock Exchange." Morgan asked, "At what time do you usually close it?" Thomas answered, "Why, at three o'clock." Morgan thundered, "It must not close one minute before that hour today!" emphasizing each word by keeping time with his right hand, middle finger pointing directly at the president of the Exchange.

Thomas then explained that unless a significant amount of money was offered on the stock exchange in a very short time, a large number of failures would result. Morgan said he would take immediate steps to arrange a loan, and he sent Thomas back to the Exchange. The situation only seemed to get more desperate with each passing moment. "One broker after another came into our office, begging us to do something -- many with tears in their eyes and others almost weak with the shock of being suddenly faced with failure," George Perkins recalled. "They had the securities on which to raise money but there was no money to be had." Finally, at about 1:45, Morgan asked that all of the presidents of the banks (not the trust companies, this time) be called to his office immediately. The city's bankers started to arrive around 2 p.m.; the moment that the brokers on the Exchange feared most would be in 20 minutes when the Exchange customarily compared all the day's sales and adjusted brokers' accounts. This would be literally a moment of reckoning.

When the bank presidents had finally gathered at the Corner, Morgan explained the situation to them. He said simply that unless they raised $25 million within the next 10 to 12 minutes, at least 50 Stock Exchange houses would fail. James Stillman, president of the National City Bank, promptly offered $5 million; the other bankers quickly fell in line. By 2:16 p.m., Morgan had secured $23.6 million from 14 banks. Within minutes, word of the new "money pool" buoyed the Street.

The panic had been stemmed but not averted. The Dow's decline dragged on for another month, which nearly pulled a major brokerage house underwater. The brokerage had collateralized many of its loans with stock in the Tennessee Coal, Iron & Railroad Co., an arrangement that threatened to destroy it and cause a cascade reaction on the market in the event of a margin call. J. P. Morgan again stepped in with an acquisition offer he had extracted from U.S. Steel: The largest steelmaker in the world would effectively buy a major competitor to save Wall Street from itself. This necessitated a last-minute meeting with President Roosevelt to ensure the White House wouldn't block the buyout on readily apparent antitrust grounds. Roosevelt, awed by projections of an economic collapse if the deal were undone, let the merger stand on Nov. 6. The panic ebbed, U.S. Steel became larger, and the Dow bottomed out three weeks later, having already sustained the worst of its decline.

The Panic of 1907, and Morgan's outsize impact on its outcome, spurred renewed national calls for banking reform. A National Monetary Commission, formed shortly after the panic, eventually devised a central-banking structure that inspired the Federal Reserve Act of 1913. J. P. Morgan, a one-man central bank, ended his career and his life on a high note, having held together the American economy and simultaneously woken up its people to the need for better banking control. He died in 1913, several months before the newly created Federal Reserve began to relegate businessmen of such momentous influence to the pages of history.

The big spinoff
DuPont (NYSE: DD  ) completed its successful IPO spinoff of Conoco on Oct. 22, 1998, raising a then-record $4.4 billion. This was a highly successful move for DuPont, which saw its spinoff's shares appreciate by a mere 9% over the offering price on the first day of trading at a time when dozens of dot-com companies were going public with first-day doubles or more. Part of this was undoubtedly due to Conoco's huge size and well-established business prospects, but a market weakened by international defaults and the failure of Long Term Capital Management also offered less enthusiasm for new issues than it had mustered mere months earlier.

DuPont, which sold 30% of its stake in the oil company in the IPO, divested its remaining stake in Conoco the following year in a "split-off" that allowed DuPont shareholders the choice of swapping each of their shares for approximately three Conoco shares. The newly independent Conoco didn't stand long on its own, as it merged with Phillips Petroleum three years later to become ConocoPhillips (NYSE: COP  ) .

Copy that
The process that gives Xerox (NYSE: XRX  ) its name was successfully tested for the first time on Oct. 22, 1938. Chester Carlson, an independent inventor, managed to create an electrophotographic image in his New York City lab, combining electrostatic printing with photography. The technique took many years to find commercial success. Carlson couldn't even find a company to license his patented technology until the Haloid Company, a small photo-paper manufacturer, signed a licensing agreement in 1946.

By the time Haloid announced its commercial intentions, a decade to the day after Carlson's first successful effort, electrophotography had been renamed "xerography," for the Greek words "xeros" and "graphein," for "dry writing." The process became the financial backbone of the renamed Xerox Corp. by 1959, when it released the Xerox 914. Revenue doubled within two years, and by the end of the 1960s Xerox's stock had driven one of the earliest tech booms, growing 6,600% over the course of the decade and creating a group of "Xerox millionaires" that rivaled any of today's modern dot-com successes.

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