I have just finished reading The Panic of 1907: Lessons Learned from the Market’s Perfect Storm, written by Robert Bruner and Sean Carr in 2007. It is an extraordinarily well documented, step by step study of one of the worst bank panics and stock market crashes in modern times. The broad stock market declined 37% from peak to trough in less than 15 months.
Here is an extended quote from the authors’ closing remarks.
“Why do markets crash and bank panics occur? Any single case study, such as the one we have presented here, is subject to a range of interpretations, and we encourage the reader to draw one’s own conclusions from the foregoing narrative.
Yet we think that the story of the panic and crash of 1907 inspires consideration that major financial crises can be the result of a convergence of certain unique forces – the forces of the market’s perfect storm – that cause investors and depositors to act with alarm.
The recounting of the events of 1907 suggests that the storm gathers as follows.
It begins with a highly complex financial system, whose very complexity makes it difficult for anyone to know what might be going wrong; by definition, the multiple parts of the financial system are linked, which means that trouble in one institution, city, or region can travel easily and quickly to others.
Buoyant growth in the economy makes the financials system more fragile, in part due to the demand for capital and in part due to the tendency of some institutions to take on more risk than is prudent.
Leaders in government and the financials sector implement policies that advertently or inadvertently increase the exposure to risk of crisis.
An economic shock hits the financials system. The mood of the market swings from optimism to pessimism, create a self-reinforcing downward spiral. Collective action by leaders can arrest the spiral, though the speed and effectiveness which they act ultimately determines the length and severity of the crisis.”
