College of Liberal Arts

University of Mississippi

Professor Finds Lessons in 1907 Meltdown to Help Deal with Current Economic Crisis

In the 1987 movie “Wall Street,” fictional character Gordon Gekko said “Greed, for lack of a better word, is good.” For the past few years, University of Mississippi economics professor Jon Moen has been using his research to understand the benefits and impact of greed.

Moen is researching the events surrounding the bank panic of 1907 and comparing them to the current economic crisis. Today’s problems, which stem from the 2007 -2008 financial meltdown, has resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world.

“Historical perspective can make seemingly mysterious events easier to understand,” said Moen, who is also chair of the Department of Economics.

In 1907 the banking crisis spurred interest in creating a central bank in the United States, ultimately resulting in the Federal Reserve System.

“The similarities between the panics of 1907 and of 2007-2008 are that they both focused on big institutions in New York City,” Moen said. “In 2007, all attention was on was Lehmann Brothers, while in 1907 it was on the Knickerbocker Trust Co. Like Lehman, Knickerbocker had to close after a run on deposits. Like Lehmann Brothers, the crisis at Knickerbocker and other trust companies caused overnight lending between businesses to freeze up.”

Overnight lending allows businesses to function from day to day when they lend to one another. When this was effectively halted, it caused real problems.

In 1907, it became clear that big national banks were operating within a regulatory framework defined by the New York Clearinghouse, but the trust companies such as Knickerbocker were not. The trust companies called in their overnight loans in a scramble to get cash to pay off panicked depositors, and the borrowers in turn had to sell the stock collateral backing the loans, threatening the stock market. The banks, on the other hand, were able to avoid liquidating their loans and were even able to buy up trust company loans. This action on the part of banks prevented a complete stock market collapse.

This sort of thing happened again in 2007-2008, when big investment banks like Lehmann Brothers, Goldman Sachs and Bear Stearns were in financial distress because their assets were based on subprime mortgages, Moen said. At the time, these intermediaries were not under the supervision of the Federal Reserve System, having no reliable lender of last resort to fall back on like the commercial banks.

“When the real estate market went down, people wondered about the value of these derivatives,” he said. “No one knew where the risk was, and there was no way to tell, so everyone was suspicious. The volume of the subprime loans wasn’t the problem, but they were used as collateral for exotic derivatives, which was the problem.”

These derivatives were used as collateral for overnight loans between investment banks and other businesses, much like in 1907.

Moen said he is not certain of the solutions yet.

“So the question is, how do we regulate it? Does the Federal Reserve need more power? Is there a bigger role for the government? What do we do? All of these answers are still being thought out,” he said. “The point is to look at 1907 because it’s simpler and easier to see the parallels in a complicated situation. It’s dangerous but familiar, so we can deal with it. People on Wall Street have always been greedy; it’s been going on for a long time.”

Moen is trying to turn his research into a book about the 1907 crisis, as well as writing scholarly papers about the incident. “I’m attending a conference organized by the Norwegian Central Bank in February to present some of the results of my research,” he said.

Moen’s advice is to be wary, because, no matter what, financiers will always attempt to get around new regulations.

“One thing to speculate is: are the problems going to shift overseas? Will there be a need for a world central bank? Will Asia be the location of the next crisis? Whatever place is next the financial regulator will have to be on the lookout for these things.”

Moen admits that it is nice to have a research life that is pertinent to current events. “It’s nice to be immediately relevant,” he said.