"Every Crisis Begins with a Shock"

An interview with Robert F. Bruner, Dean, Darden Graduate School of Business Administration, University of Virginia

Last year, on the 100^th anniversary of their book's subject, Robert F. Bruner and Sean D. Carr published The Panic of 1907: Lessons Learned from the Market's Perfect Storm (John Wiley & Sons). A year later, as we weather a far greater financial storm, the book's lessons are more relevant than ever. From their analysis of one of the worst banking panics in U.S. history, when dozens of banks and trust companies failed, Bruner and Carr conclude that financial crises typically result from the convergence of certain elements into a "perfect storm." The book is an engrossing read, featuring characters such as Augustus Heinze, the brash entrepreneur; Charles Barney, the tragic trust president; and, above all, J.P. Morgan, Wall Street's indispensable man. Bruner, who is Dean and Distinguished Professor at the University of Virginia's Darden Graduate School of Business Administration, recently talked to CFO about how much the crises of 1907 and 2008 have in common.

The Panic of 1907 began in October of that year, when Augustus and Otto Heinze attempted and failed to corner the stock of United Copper Co. But, just as our current financial crisis took at least a year to bloom, you say the same was true in 1907?
It's a misconception to believe that financial panics and crises are due to just a panicky world of depositors and investors. A panic has to start with something. Every crisis has at its core a real economic shock — and the shock is unambiguous, costly, and surprising. The shock in the case of 1907 was the earthquake that devastated San Francisco in April 1906. That earthquake triggered insurance policies to be honored by companies around the world. It drew gold, which was the currency of the day, out of the major financial centers of the world to San Francisco, in order to pay for rebuilding the city.

The United States of the day was the equivalent of China or India today: it was the engine of growth for the world. When the earthquake hit, it merely amplified a demand for capital that had been growing for decades.

The flow of gold to the United States prompted European central banks to raise interest rates to draw gold back to their financial centers. The tug-of-war for capital was slowly being won by the Europeans. It created a liquidity crunch that by late 1906 was in full swing. In March 1907, the "silent crash" saw the market lose about 10 percent of its value in a couple of days. That was the turning point of sentiment.

Other events presaged the actual panic.
Yes. One was the difficulty New York City had in refinancing its bonds. Essentially, the city borrowed on a short-term basis to fund some of its capital and operating expenditures. But it withdrew a bond issue in June when it couldn't sell bonds at what the city council believed were fair yields. The city sampled the market again in July, but again had no luck. By August, conditions were getting perilous. At that point J.P. Morgan stepped in as an adviser and underwriter. He convinced the city council to agree to some extra conditions and a slightly higher yield and was able to place the bond issue in Europe.

Morgan was lauded as the savior of the city. Thinking that the difficulty was behind the markets, he went off to Richmond, Virginia, to attend a triennial convention of the Episcopal Church, in which he was a warden. Thus Morgan was absent during the second proximate trigger of the crisis, which was the attempt at speculation in the shares of United Copper.

Now we come to the infamous Heinze brothers.
That's right. Augustus Heinze was a rough-and-tumble businessman from the copper fields of Montana. He had cobbled together a series of mining interests that represented a sizable portion of the copper industry. Heinze abruptly sold those interests to Amalgamated Copper, a company backed by the Rockefellers, and went to New York to make his mark as a financier. He bought an interest in a number of banks and trust companies but retained his stake in United Copper, one of the core companies on which he had built his fortune.

As the economy receded over 1907 Heinze grew more and more skeptical about the decline in the price of United Copper. He came to the conclusion that the company was the subject of a bear raid, where speculators were selling its shares short. So he attempted what is commonly called a bear squeeze. He began buying shares of his own company in volume, and the share price rose and rose. In those days settlement could occur the next day, or weeks or even months later. He allowed the positions to remained unsettled, and then on October 16 demanded that the shares he had bought be delivered.

His brother Otto played a key part in this maneuver.
Otto was a broker running Otto Heinze & Co., which was one of the two key brokerage firms through which the bear squeeze was implemented.

So on October 16 Augustus demands settlement. He thinks he already owns most of the shares of United Copper, and that short sellers will have to buy shares from him in order to settle their positions.
Yes, and the shares began rolling in. They get delivered and delivered and delivered, and to Augustus Heinze's astonishment, there were shares to back up all of the purchases he had made. By some fluke he had simply misestimated the volume of shares outstanding and was faced with an enormous cash outlay in settlement of these shares.

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