Economic Effects of Runs on Early Shadow Banks: Trust Companies and the Panic of 1907

The Panic of 1907 occurred following a period of rapid financial innovation, in which a relatively new form of financial intermediary, the trust company, became significant lenders.  Exempt from the strict regulations imposed on national banks, trust companies were ‘shadow banks,’ and by the outbreak of the panic New York’s shadow banking system was nearly as large as its formal banking system. The outbreak of the panic occurred following a series of scandalous revelations about the investments of some prominent New York financiers. Some of those financiers were prominently associated with trust companies, resulting in widespread runs on trust companies throughout New York City. The connections between the trust companies that came under severe strain during the crisis, and their client nonfinancial firms, may have transmitted the financial crisis to nonfinancial companies. Using newly collected data, this paper investigates whether corporations with close ties to trust companies were differentially affected during the panic. The results of the analysis indicate that firms affiliated with the trust companies that faced severe runs performed worse in the years following 1907 across a variety of measures, such as profitability and interest costs. Most importantly, the impact of affiliations with New York’s hardest-hit trust companies accounted for at least 18.1 percent of the total contraction in corporate investment in the United States in 1908.