Now let us consider another cause of the panic--the currency system, always bearing in mind the fact that the first and greatest cause of the panic was the over-expansion outside of New York that has just been described. The causes which we are now to consider were of minor importance when measured by this overshadowing matter; nevertheless they played their part and must be considered accordingly.
Not all panics, to be sure, can be prevented by a perfect currency system, yet this one could have been measurably prevented, and “Wall Street” and the Stock Exchange had labored for years so to prevent it. At the gatherings of the Chamber of Commerce, at the bank meetings, at all the meetings of merchants and manufacturers for years preceding 1907, the mischievous effects of our currency system were proclaimed and the ultimate outcome predicted. Congress was petitioned again and again to remedy those intolerable conditions, and to permit national banks to expand their circulation under proper safeguards, but without avail.
When the storm burst, a most impressive object lesson in practical finance resulted. What was at worst but a normal stringency of the circulating medium developed, when added to abnormal demands from the country at large, into conditions that created great alarm. There was no way by which the banks of the country could use the resources which they actually possessed to meet the urgent requirements of the hour. A great nation of enterprising people found itself--and still finds itself--compelled to do a banking business differing in degree, but not in kind, from the old-woman-and-her-stocking system of finance. The way our bankers got down on their knees to London and Paris in that emergency, frankly admitting their inability, under our old flint-lock laws, to handle a situation which foreign bankers meet without difficulty, is a subject at once painful and humiliating. Literally our bankers begged for help and got it. Some day we shall have to beg again.
Had the national banks of New York City enjoyed the right to expand their circulation in the manner provided by the plan of the American Bankers’ Association, at least a part of the débacle would have been avoided. “The banks and trust companies of this city have in their vaults the largest store of good credit that can be found in any city in the world,” said one of America’s foremost economists as the panic raged, “but much of it is utterly unavailable because of our currency system. One of the trust companies that closed its doors has in its possession live assets amounting to over $50,000,000. All this credit is dead. It cannot do the work of a single dollar in the paying-teller’s cage. What is wanted in a time like this is freedom to convert the credit of banks into a medium of payment that will satisfy the people.”[72]
True enough, and just what the whole financial community, including the Stock Exchange, had been repeating for years. Currency issues which do not provide for _all_ situations, including not only ordinary demands, but also such exceptional cases of shrinkage as this one was, can never be called perfect, nor even safe. There is no health in them.[73] The most effective and the most rapid means of regulating and protecting the general credit situation is by increasing or diminishing the volume of outstanding bank-note currency not covered by a reserve of gold or other lawful money. This method is employed successfully both in France and in Germany. The Bank of France and the Imperial Bank of Germany to some extent regulate credit conditions by acting as central banks of discount; but their most effective action is by increasing or diminishing the uncovered amount of their outstanding notes. When additional currency is needed as a circulating medium they supply this currency by issuing notes. When contraction of currency, or a check upon the further expansion of bank credits is desirable, they accomplish the result by diminishing the volume of their outstanding notes and by raising the discount rate. This system is as nearly perfect as any yet devised.[74]
Whether we shall ever succeed in adopting it, or something like it, in America, is the burning question in our banking offices to-day. Until something is done, the layman who distrusts the plan of a central bank and looks upon Wall Street with abhorrence, may find satisfaction in knowing that the average New York banker is the most worried and harassed man in American business life. With millions of other people’s money in his possession subject to withdrawal by check at sight, and with millions of the best security in the world in his vaults lying absolutely idle and worthless so far as raising currency is concerned, he stands between the devil and the deep-blue sea. Anything that frightens his depositors, or even remotely suggests panic, gives him a cold chill. People who talk of manipulation by New York bankers as a cause of the panic of 1907 or any other panic are blind to the fact that any disturbance of normal conditions is the one thing that bankers would avoid as they would avoid the plague.
There was a third cause of the panic in the course pursued by the President. In some quarters it is still termed “the Roosevelt panic,” and there exists a belief that the President by his actions and speeches played a large part in bringing about the crisis. Personally, I feel that this has been exaggerated. There had been, unquestionably, wrongdoing by certain corporation managers. The President, with a characteristic vigor not unknown to politicians, seized upon it as a theme for his speeches, and the “evils,” the “malefactors,” the “corruption” and “dishonesty” with which he bruised the air, raised a suspicion in many quarters as to the status and security of the whole financial situation and undoubtedly contributed to the frightened liquidation of the day. The impression these utterances produced abroad, where American securities were popular, was painful, and led one returning tourist to remark that Europe was acquiring the idea that we were “a nation of swindlers.”
All panics are largely psychological, and this was no exception. The President’s public speeches came at a time when emotion, apprehension, and alarm filled men’s minds; and at a time when those irrational moods were most likely to exaggerate the difficulties that existed, and to conjure up difficulties that did not exist. Panics _seem_ to come from lack of money, the real difficulty is lack of confidence, and it was to this that the President’s course directly contributed.
I am of the opinion that, judged by his public utterances, especially his October speech at Nashville, Tenn., the President had not the remotest idea that such an awful shock as the panic of 1907 was imminent. He was not a student of economic conditions; he had no familiarity with crisis-producing phenomena; he had never seen a panic at close quarters. His speeches did not cause the panic, for that disturbance was foreordained; they served, however, to hasten it, to intensify it, and to keep it alive. Perhaps I may add that the sparks beaten by him from the anvil of political expediency at that unfortunate moment threw more light upon the President himself than upon the evils he condemned. Perhaps, too, that was what the President most desired. In any case, the fact remains that just as there is too much confidence in times of excessive expansion, so there is too little in times of unreasoning depression; and that the President’s attitude aggravated the latter situations is undeniable.
But by what stretch of the imagination can the Stock Exchange be credited with playing any part in this third cause of the panic? If temporary depression results from exposure of wrongdoing among railroad, industrial, or financial institutions, nowhere in the land is execration poured forth upon the evil-doers more vigorously than within its four walls. Far from complaining, the Stock Exchange and the whole investment community welcome such exposures, despite their effect on the market, for the precise reason that their own protection and benefit, if nothing else, is promoted by it.
There was yet another reason for the panic, closely related to the attitude of the President. I refer to the predicament of the railways of the country as 1906 passed into 1907. Staggering under a load of traffic which sorely taxed their equipment, the managers of these properties cried aloud to the investing public for funds. But capital was not to be had. Tied up in real-estate speculation and in quarters whence it could not be easily recovered, the normal supply of capital was immobile and inert. What was worse, encouraged by the attitude of the President, an epidemic of radical anti-railroad legislation became manifest in the several States, new and onerous burdens of taxation were imposed, and a wave of distrust and suspicion regarding railway investments was created. Simultaneously the cost of wages and materials advanced--both characteristic phenomena indicating trouble--and, as a consequence of all this blockade, the ratio of net to gross in the matter of increased earnings fell from the normal proportion of about 40 per cent. in the first nine months of 1906, to less than 10 per cent. in the same months of 1907.
Railroads are public utilities that must continue to handle business offered them no matter what happens, and so, to meet all these abnormal demands, but one course was left open to them, and that was to raise funds by issues of new stock. This, of course, amounted practically to an assessment of stockholders; as an expedient it failed because “Wall Street” had already recognized the symptoms of disease. It was too late. Money and credit attract money and credit, and confidence attracts both. There was a shocking absence of confidence in the emergency of 1907, and the railroads suffered enormously by it.
With this matter certainly Wall Street had nothing to do; it could not in fact do more than it had just done in pointing out to the country at large, through a drastic process of liquidation, the obvious withdrawal of far-sighted investors from a situation that had become tense. Nor can the railroads be censured, because the great volume of business that confronted them was not created by them, and yet had to be transported by them. The fault lay, of course, in the wholesale and reckless expansion of all lines of industry, and in the immensely increased extravagance of public and private life.
I venture the prediction that when these conditions again prevail, as they must in a great and vigorous country like ours, the Stock Exchange will still be found sounding its warnings, but it will not do to hope that those who learned the bitter lesson of 1907 will profit by that experience, because the condition of _mental_ disturbance which is a part of every panic cannot be regulated by the will, nor kept within bounds by the statute law. The one lesson we have learned from the predicament of the railroads in 1907 is that there is a tendency toward disturbance in large accessions either of business or of capital. “At intervals,” says Walter Bagehot, “the blind capital of a country is particularly large and craving; it seeks for some one to devour it, and there is ‘plethora’; it finds some one, and there is ‘speculation’; it is devoured, and there is ‘panic.’”[75]
Summarized briefly, I have attempted to show in the foregoing pages that the Stock Exchange for many months prior to the panic had been steadily liquidating and contracting, and had served notice on the country at large that the time had come to put a stop to the prevalent over-expansion. It has been demonstrated that instead of heeding these warnings the general business of the country, as evidenced by the increases in loans and commercial discounts and by an over-speculation in real estate and in public and private extravagances, continued to expand up to the very eve of the panic, and was stopped then and there only by sheer lack of capital. Nothing can be of greater importance in any consideration of the 1907 crisis than that its overshadowing cause was the attempt to do too much business on too little capital, and compared with this all other aspects of that situation are of minor importance.
I have shown that an antiquated currency system played a conspicuous part in the crisis, through contributory negligence on the part of our law-makers. The part played by the President has been cited as a third, though somewhat negligible, factor in sowing the seed of distrust, and also the trying position in which the great common carriers of the country found themselves after the seeds of distrust had been sown. These were the four causes of the panic of 1907.[76]
How well the Stock Exchange did its work in that great emergency is a matter of record. It did not close its doors; there were no failures; no relaxation of the protection afforded the public; no departure from the high standard of morality which is ever its goal. In one week, ending October 25th, 5,166,560 shares passed through its hands, representing, with the transactions in bonds, a par valuation exceeding $483,000,000.
Now, in the very nature of things, a financial panic is the inability of many debtors to meet their obligations, plus the fear that many others may be in the same plight. At such a time men hasten to sell for cash that for which there is the readiest market. Thus they sell securities because securities are immediately convertible; thus they turn to the Stock Exchange, because that is what Stock Exchanges are for. Hence it follows that in a crisis such as that of 1907 the ruinous decline manifests itself more sharply, and is felt more keenly, on the Stock Exchange than on the Cotton Exchange or the Produce Exchange. Men turn to it for first aid to the injured, and the greater the casualty list, the more marked is the disturbance of values. That this is not well understood by the public often unfortunately leads to suggestions of improper methods where none exist.
Finally, where do we stand? Orthodox economists like Wells talk of over-production as a cause of panics; currency experts bewail a lack of circulating media; theorists of the school of Jevons are driven to seek in sun-spots the potent force of all our harvests; Levi and Mill dwell upon the periodicity of panics and would fix their appearance by schedules of time; politicians and thinkers-in-embryo point the finger at Wall Street, and yet, with all that has been written, thirteen great crises at home and abroad within the last century show that we have not begun to get at these disturbances. Drought has been a cause of mischief, yet we have learned to irrigate and to conserve; epidemics have smitten us, yet we have mastered sanitation; floods have ruined whole territories, yet we have built dikes and levees. But every now and then, when business seems to be at its best, when merchants are dividing large profits, and when labor is best rewarded, a panic occurs and the whole structure collapses.
To say that Wall Street or Lombard Street or any group of men anywhere can bring such conditions to pass is to deny all the facts of experience. Depressions may come from any of a hundred causes, but panics originate in the mind; they are manias. Walter Bagehot gave up trying to prescribe for them because he realized that sudden frenzy is not an ailment to be foreseen and prevented. “But one thing is certain,” he said, “that at particular times a great many stupid people have a great deal of stupid money;” to which he adds, “our scheme is not to allow any man to have a hundred pounds who cannot prove to the Lord Chancellor that he knows what to do with a hundred pounds.” When thousands of people ignore all the warnings of experience, as they always will do; when with a blind misdirection of energy they sink borrowed capital in quagmires at fancy prices, as they always have done; and when, shorn of their all, they are simultaneously seized with a mania to denounce others for the consequences of their own folly, as they always must do, one cannot avoid the thought that perhaps Bagehot’s humorous solution is the best that has been devised.[77]
CHAPTER VII
A BRIEF HISTORY OF LEGISLATIVE ATTEMPTS TO RESTRAIN OR SUPPRESS SPECULATION
In the Middle Ages the notion prevailed that there was a just and equitable price for everything, and that any person who tried to obtain more than this price was a sinner. Trade for gain was anathema; the man who bought the principal commodities of that time, such as corn or herrings, with a view to selling them at a profit, was guilty of “craft and sublety”--as the old English statutes read--that infallibly cost him his goods and brought him to the pillory. Thus in the year 1311 one Thomas Lespicer of Portsmouth was caught red-handed in London with six pots of Nantes lampreys stored in a fishmonger’s cellar in the hope of a rising market. The law required that when he arrived in London from Portsmouth with his lampreys he should proceed to the open market under the wall of St. Margaret’s Church in Bridge Street, and stand there four days selling at current prices to any one who cared to buy. His failure to do so, and his wickedness in attempting to “bull” the lamprey market by hiding them in the fishmonger’s cellar, resulted in the arrest of himself and the fishmonger, and their trial and punishment at the hands of the Mayor and Alderman.
Professor W. T. Ashley, who cites this incident in his “Introduction to English Economic History and Theory” (London 1892), also gives another instance in which our modern theories of natural rights and freedom of contract seem to be in hopeless conflict. John-at-Wood, a baker, was arrested in 1364 charged with the profane practice of “bulling” wheat. “Whereas one Robert de Cawode,” the indictment reads, “had two quarters of wheat for sale in common market on the pavement within Newgate; he, the said John, cunningly and by secret words whispering in his ear, fraudulently withdrew Cawode out of the common market, and they went together into the Church of the Friars Minor, and there John bought the two quarters at 15½d per bushel, being 2½d over the common selling price at that time in the market, to the great loss and deceit of the common people, and to the increase of the dearness of wheat.” At-Wood denied this heinous offence and “put himself on the country,” whereupon a jury was empanelled, which gave a verdict that At-Wood had not only thus bought the grain, but that he had afterward returned to the market and boasted of his crime, and “this he said and did to increase the dearness of wheat.” Accordingly he was sentenced to be put in the pillory for three hours, and one of the sheriffs was directed to see the sentence executed and proclamation made of the cause of the punishment.
So far as I am aware the Statutes of Henry III and Edward I, under which these culprits were punished, constitute the earliest official attempts to repress speculation by law. After the Revolution, the Bank of England having been organized and bank shares created, a speculative outburst occurred that led to the enactment of fresh legislation entitled “An act to restrain the numbers and ill practices of brokers and stock-jobbers,”[78] but this law lapsed or was repealed ten years later. In 1707 a law was passed licensing brokers and making it unlawful for unlicensed brokers to do business,[79] and in 1708 City rules were established for brokers, obliging them to give bonds for the proper performance of their duties. In 1711, 1713, and 1719, laws were enacted similar to the Act of 1707.
Then came the speculative schemes of 1720, of which the most famous or infamous was the South Sea Company, designed to make fortunes for its shareholders in the slave-trade and in whale fishing. It was followed by many other projects almost fantastic in their wildness to each of which the public subscribed liberally. Where all the money came from that kept this disastrous speculative mania alive is something one would like to know. There seems to have been no limit to it. South Sea shares stood at 120 in April of 1720; in July they had reached 1020, and, after that, the collapse. The company became a “bubble,” and a burst one at that--and a great popular outcry followed. It resulted, in 1734, in the passage of Sir John Barnard’s “Act to Prevent the Infamous Practice of Stock-Jobbing,” the preamble reciting:
“Whereas, great inconveniences have arisen, and do daily arise, by the wicked, pernicious, and destructive practice of stock-jobbing, whereby many of His Majesty’s good subjects have been and are diverted from pursuing and exercising their lawful trades and vocations to the utter ruin of themselves and their families, to the great discouragement of industry, and to the manifest detriment of trade and commerce.”
This act forbade bargains for puts and calls, and also “the evil practice of compounding or making up differences”; but its principal provision was the prohibition of short selling under penalty of £100 for each transaction. There was, of course, an appeal to the courts, which held that the statute did not apply to foreign stocks nor to shares in companies, but only to English public stocks, a decision that effectually put an end to the usefulness of the law. It remained on the statute books, however, and it was occasionally resorted to by persons who sought to evade the fulfillment of their speculative contracts--a class of persons known to-day as “welchers.”
Finally, in 1860, the law was repealed altogether, the repeal act reciting that Sir John Barnard’s Act “imposed unnecessary restrictions on the making of contracts for sale, and transfer of public stocks and securities.” Thus the first serious attempt to regulate speculation in securities by law, and specifically to prohibit short selling, came to be recognized as a failure by the frank admission of government. In 1867 the so-called Leeman Act became law, prohibiting all sales of bank stock unless the numbers of the certificates sold were specified--an attempt to prevent short selling of bank stock. Even this law was subsequently repealed, and England, to-day, has no law on the statute books restricting speculation.
As the London Stock Exchange grew in influence and importance, reflecting England’s development as the world’s banker, popular attack and criticism continued to assail it. It may be frankly admitted that the legitimate functions of the institution had been abused by foolish or unscrupulous persons, just as every important branch of business and politics has been misused, the world over, since civilization began. The question therefore arose whether these occasional sharp practices proved the Exchange to be an excrescence on the body politic, or whether, on the other hand, its importance in the mechanism of modern business merely required improvements and reforms. In this situation, which occurred in 1877, and which caused considerable agitation on the part of both parties to the controversy, a royal commission was appointed “to inquire into the origin, objects, present constitution, customs, and usages of the London Stock Exchange.” The Exchange and its critics thus reached the parting of the ways. A year was spent by the commission in examining witnesses and conducting investigations along special lines, and in 1878 its report, with the evidence, was published in a Parliamentary Blue Book.
The report absolutely upheld the purposes and functions of the Stock Exchange and the legitimacy of speculation in securities, and it went further in pointing out the danger of attempting to force any form of external control on the institution. The evils of that form of Stock Exchange speculation which closely approaches mere gambling were plainly stated, and the report suggested that the Exchange authorities restrain such practice in so far as was possible.
As the conclusions of the royal commission are of very great importance, marking as they do the first serious official study in modern times of the Stock Exchange theory, I quote from the Blue Book in the hope that Stock Exchange critics of to-day may understand how these conclusions were reached. “In the main,” reads the report, “the existence of the Stock Exchange and the coercive action of the rules which it enforces upon the transaction of business and upon the conduct of its members has been salutary to the interests of the public. We wish to express our conviction that any external control which might be introduced by such a change should be exercised with a sparing hand. The existing body of rules and regulations have been formed with much care, and are the result of the long experience and vigilant attention of a body of persons intimately acquainted with the needs and exigencies of the community for whom they have legislated. Any attempt to reduce this rule to the limits of the ordinary laws of the land, or to abolish all checks and safeguards not to be found in that law, would, in our opinion, be detrimental to the honest and efficient control of business.”
In 1909 similar criticism in New York having led to the appointment of the Hughes Commission to inquire “what changes, if any, are advisable in the laws of the State bearing upon speculation in securities and commodities, or relating to the protection of investors, or with regard to the instrumentalities and organizations used in dealings in securities and commodities, which are the subject of speculation,” the commission reported to the Governor, after six months of laborious investigation, in these words:
“Speculation in some form is a necessary incident of productive operation. When carried on in connection with either commodities or securities it tends to steady their prices. Where speculation is free, fluctuations in prices, otherwise violent and disastrous, ordinarily become gradual and comparatively harmless. For the merchant or manufacturer speculation performs a service which has the effect of insurance. The most fruitful policy will be found in measures which will lessen speculation by persons not qualified to engage in it. In carrying out such a policy exchanges can accomplish more than legislation. We are unable to see how a State could distinguish by law between proper and improper transactions, since the forms and the mechanisms used are identical. Rigid statutes directed against the latter would seriously interfere with the former. Purchasing securities on margin is as legitimate a transaction as the purchase of any property in which part payment is deferred. We, therefore, see no reason whatsoever for recommending the radical change suggested that margin trading be prohibited.”
Here are two reports at an interval of thirty-one years, made by independent investigators of high character, concerning the two foremost Stock Exchanges in the world. Both of these reports recommend changes and improvements, and each is firmly of opinion that the changes recommended are such as can be carried out by the Stock Exchanges themselves without the assistance or interference of the legislature.
As the London Stock Exchange is a voluntary association similar to that in New York, it was inevitable that the question of incorporation should have been brought before the royal commission of 1877, and that the question as to whether the public interest would be promoted by such incorporation should be given careful attention. As a result of these deliberations, a majority of the commission recommended that the London Stock Exchange should voluntarily apply for a royal charter or act of incorporation, but the reasons upon which this recommendation were based had to do with the temporary or shifting character of the membership, which gave very little assurance to the public of the permanence and stability of the rules, since members of the London Stock Exchange are only elected for one year. It need scarcely be added that such an argument would not apply to the New York Stock Exchange.
Now it so happened that, despite this opinion by the royal commission, the London Exchange was not compelled to incorporate, and remains to-day a purely voluntary association or club. The reason for this lies, in large measure, in the very intelligent minority opinions filed with the Board’s report by those of its members who dissented from the recommendation. As this is a matter of interest to members and friends of the New York Stock Exchange, I give herewith the substance of these dissenting opinions, calling the reader’s attention to the fact that the Hughes Commission of 1909 rejected similar proposals regarding the New York Stock Exchange.[80] The Hon. Edward Stanhope, M. P., said, regarding the proposed application for a charter:
“Supposing such an application to be made, and Parliament to be prepared to incorporate the Stock Exchange on the terms which are embodied in the report, the consequence would be that rules so established would be stereotyped, and could only be altered, even in the minutest details, with the approval of a department of the State. In my opinion this requirement would be either mischievous or nugatory. To attempt to regulate the manner in which business is conducted in the great money market of England is going far beyond the province of the State, nor is any government department in any way qualified to undertake it. The report, indeed, recommends that external control should be exercised with a sparing hand. But experience seems to show that the first commercial crisis, or the discovery of any gigantic fraud, would cause a pressure for further restrictions which the department entrusted with these duties could not possibly withstand. If incorporation is to be anything more than a theory, it seems to me that it must either be imposed compulsory upon the Stock Exchange, or it must be offered to them on terms which will make it worth their while to accept it. The first alternative I reject, for the reason given by the select committee on foreign loans, that it would destroy that freedom which is the life and soul of the institution. If, however, any voluntary scheme commends itself to the opinion of the Stock Exchange, its primary condition should be to reserve to that body absolute liberty in the transaction of their ordinary business (as to which we are all of opinion that, speaking generally, no just fault can reasonably be found), and also the power of adapting their rules, with the utmost ease and freedom, to the varying wants of the time.”