That was certainly the case with the first significant outbreak of bank runs in November 1930 when the Caldwell banking chain collapsed. A speculative pyramid of holding companies which controlled more than a hundred banks in Tennessee, Arkansas, and North Carolina, it failed when real estate values fell sharply in the upper Cotton Belt. While there was some spillover on local banks, the runs did not spread beyond the region and quickly burned out because deposits were moved to sounder banks, not to mattresses.
The most powerful evidence of the noncontagious nature of the pre–February 1933 bank failures occurred shortly thereafter with the famous collapse of the Bank of the United States in December 1930. An upstart New York City bank, the Bank of the United States, grew by leaps and bounds in the late 1920s through serial mergers, aggressive real estate lending, and pyramiding of holding company capital.
The bank had been a stock market rocket ship, rising from $5 per share in 1925 to a peak of $230 before the crash. But its promoter, one Bernard Marcus, who had been the Sandy Weill of his day, had been more adept at making deals than making sound loans, and thereby soon rendered his hastily assembled banking empire insolvent. Yet there was virtually zero spillover to other New York banks when state banking supervisors shuttered what was then the city’s third-largest institution with around seventy branches and deposits on the order of $30 billion on today’s scale.
The same pattern occurred the following June in Chicago. There had been a giant real estate bubble in the Chicago suburbs during the 1920s, but owing to Illinois’s particularly restrictive anti-branch-banking law the Great Loop banks had been sidelined, leaving the suburban real estate lending spree to poorly capitalized newbies.
Chicago had been an epicenter of the 1914–1929 agricultural/industrial/export boom, so when the party ended abruptly after the stock market crash, the region’s economy was hit harder than any other industrial center outside of Detroit. Real estate prices experienced a particularly devastating collapse in the newly developed suburban communities, triggering a wave of defaults in loan portfolios which were heavily laden with commercial and residential mortgages.
Yet with one exception a year later, the Great Loop banks remained solvent and experienced no lines at their teller windows. By contrast, the “runs” on the suburban banks were both swift and warranted because they were deeply insolvent. In short, the Chicago case further illuminates the fact that the wave of bank failures during 1930–1932 was not the result of irrational public sentiment and “contagion,” or a fundamental breakdown of bank liquidity, but instead was evidence of a discriminating, rational flight of depositors from unsound banks and markets.
Even when surges of bank failures extended eastward, such as in the Philadelphia runs of October 1931, there was far more rationality to the pattern than the conventional narrative acknowledges. In this case, the overwhelming share of failures was concentrated among newly formed “trust banks” which had been chartered under state law with far less stringent requirements for capital and cash reserves than was the case with national banks.
Again, the late 1931 wave of bank failures in Philadelphia quickly burned out after deposits had moved from the lightly regulated trust banks, which had been on the leading edge of real estate lending and securities speculation, to the far better capitalized national banks. Indeed, the fundamental solvency of the US banking system was dramatically evidenced during this same period when the Fed raised the discount rate in mid-October.
This Fed action is habitually and roundly criticized by contemporary advocates of central bank money printing, but it was actually the proper move under then-extant gold standard rules. Specifically, the initial impact of the British default on September 1931 had been a run on US gold out of fear that the United States would be the next to default. So a discount rate hike was necessary to stop the outflow and, in fact, the rate of gold losses fell sharply in the months ahead and eventually reversed to an inflow by mid-1932.
More importantly, there was no acceleration of bank failures after the discount rate hike, and within weeks the failure rate slackened dramatically while discount borrowings actually increased. This was proof positive that banks were failing not because they were illiquid or could not get emergency funding from the Fed but because they were, alas, bankrupt.
Indeed, Herbert Hoover’s unfortunate banking cure at the time—the emergency enactment of the Reconstruction Finance Corporation (RFC) in January 1932—was designed to alleviate insolvency, not provide emergency funding or replace hoarded deposits. Accordingly, the RFC went on to become a paragon of crony capitalism, rescuing dozens of busted railroads and recapitalizing several thousand insolvent banks. Yet the outcome was perverse: the stock and bondholders of bailed-out institutions were rescued, competitors were harmed, and the nation’s economy was left to slog it out with far too much railroad capacity and way too many banks.
THE BANKING CRISIS WAS OVER
BEFORE FDR GOT STARTED
Nevertheless, the so-called banking crisis was largely over on the night of FDR’s November 8, 1932, election. Nationwide bank failure rates had dropped to less than two dozen per week of mostly tiny country banks, deposit levels were rising, and what remained was a modest cleanup operation for the residue of insolvent banks in the hinterlands.
This adjustment process had now been heavily politicized, meaning that banks sinking into insolvency would receive capital injections from the RFC rather than closure notices from state and federal banking supervisors. But the key point is that there was no significant liquidity problem in the US banking system. The Federal Reserve, bank regulators, and discriminating depositors had already done their jobs and had quietly and systematically moved massive amounts of deposits to sounder banks.
The conventional FDR bank rescue narrative thus cannot explain the fact that during the ninety days between Election Day and February 3, when FDR went aboard Vincent Astor’s yacht for a ten-day vacation he had not yet earned, there were no bank runs of any serious import. The proof for this is the daily reports of the comptroller of the currency, which didn’t note any material currency hoarding until early February.
In fact, during the three-month post-election period there were only two instances of a citywide banking suspension for even a single day anywhere in the country. Likewise, currency outstanding had fluctuated around $5.5 billion for most of 1932, and even in the week ending February 8, 1933, had only risen by a negligible $8 million per day.
By contrast, partisan historians have created the false impression that there was a rising tide of money panic by cobbling together inconsequential anecdotes from the low-level bank failure noise still in the countryside. Thus, the governor of Nevada declared a bank holiday in November, but it was owing to the insolvency of a single bank chain that had only $17 million of deposits, or less than a few hours’ worth of funds-clearance activity at the Chase National Bank or even the big Chicago Loop banks.
Likewise, scattered rural bank failures in Missouri, Tennessee, and Wisconsin and in midsized cities in the interior farm-industrial belt including Chattanooga, Memphis, and Little Rock were simply a continuation of the slow grind that had gone on for years. Some of the noise was even downright clownish, such as Huey Long’s instantly declared state holiday in honor of the 1917 suspension of diplomatic relations with Germany, in order to give a major Louisiana bank time to raise extra cash.
The trigger for the pre-election panic, in fact, did not occur until the morning of February 14, when the governor of Michigan capriciously declared a one-week bank holiday owing to a funding crisis at Detroit’s second-largest banking chain. The Guardian Trust Group consisted of about forty banks controlled by Edsel Ford and included Goldman Sachs among its principle stockholders.
It was another of the late-1920s banking pyramids that had been organized with a modest $5 million of capital in 1927 and had grown to a $230 million holding company two years later, through a spree of mergers and stock swaps. These maneuvers elevated t
he stock price from $20 per share to $350 at the 1929 peak.
Unfortunately, the bank’s principle assets consisted of loans to insiders to buy the bank’s own stock and loans to both real estate developers and homeowners in the red-hot Detroit auto belt. Propelled by a population explosion from 300,000 to 1.6 million in the previous three decades, the volcanic price gains in the Detroit real estate market eclipsed the current era’s Sunbelt booms by orders of magnitude.
Consequently, when auto production dropped by 75 percent and triggered mass layoffs, and the Guardian Group’s stock price plummeted by 95 percent, the bank’s loan book became hopelessly impaired. However, what might have been embarrassing investment liquidation for Edsel Ford and his cronies became a national headline when the Guardian Group crisis turned into a brawl between Henry Ford and his despised erstwhile partner and then Michigan Democratic senator, James Couzens.
Senator Couzens was the Tyler Winklevoss (he and his twin brother were involved in the origins of Facebook) of his day and believed that he had been bilked out of his share of Ford Motor Company by Henry Ford. He could not abide a move afoot to have the RFC ride to the rescue of Edsel Ford’s mess, so he mustered his considerable weight as US senator and put the kibosh on the deal.
President Hoover unhelpfully got himself in the thick of the brawl. However, he did quickly recognize that the Detroit headlines were becoming a catalyst for a financial panic that was already brewing due to a complete breakdown of transition cooperation and FDR’s studied silence on his prospective financial policies.
Indeed, the increasing flow of hints and leaks from FDR’s radical brain trusters—such as Columbia professor Rexford Tugwell and secretary of agriculture designate Henry Wallace—that the incoming president would depreciate the dollar and pursue other inflationary schemes had already begun to trigger a run on gold and currency. Therefore, on February 18 Hoover penned an eloquent private letter to FDR outlining the peril from these developments and the urgent need for a reassuring statement from the president-elect outlining his policies with respect to gold, currency, banking, and the budget.
THE FOURTEEN-DAY ROOSEVELT PANIC
Thereupon began a continuous series of blunders, whereby FDR and his incipient government brought the banking system to a state of paralysis and panic by the time he took the oath of office fourteen days later. During that crucial period, FDR remained completely radio silent, and did not respond to Hoover’s letter for ten days—belatedly offering the “dog ate my homework” prevarication that his secretary had neglected to mail his response. On the day of Hoover’s letter, the Democratic silver block in the Senate delivered a nationwide radio address entitled “The Enlarged Use of Silver and Inflation.” On the following Monday the nation’s greatest banking statesman, Melvin Traylor, who was chairman of one of the great Chicago Loop banks and had been a leading candidate for the Democratic presidential nomination in 1932, told the Senate Finance Committee in a private session that “a firm statement from the President-elect against inflation is the only thing which might avert a general national panic.”
The next day the Federal Reserve Advisory Committee, consisting of leading bankers from each reserve district, sent FDR a unanimous resolution urging a clarifying public statement. That same day it was announced that Carter Glass had turned down the Treasury Department post and, as the Baltimore Sun story made clear, there was no secret as to why: “If satisfactory assurances had been given the Senator that the new Administration under no circumstances would accept inflation as a policy, his answer would have been different.”
Instead, Roosevelt announced that an unknown Republican locomotive manufacturer, William Woodin, would become treasury secretary and the basis for his selection was quickly evident. Notwithstanding daily entreaties from Hoover’s redoubtable and increasingly desperate treasury secretary, Ogden Mills, the response was a complete stiff-arm: “On each occasion Mr. Woodin insisted the new administration would take no action, accept no responsibility, until March 4.”
According to an insider chronicle written at the time, by February 24 FDR and his inner circle had already embraced a purely cynical outlook. By their lights “the national banking situation would undoubtedly collapse in a few days. The responsibility would be entirely with President Hoover.”
In fact, that same day Professor Tugwell, who was clueless on monetary matters, leaked the administration’s secret plan to place an embargo on gold exports, suspend gold payments to domestic citizens, and implement measures designed to inflate farm and industrial prices to James H. Rand. The latter was a leading industrialist and outspoken agitator for dollar depreciation through the nationalistic Committee for the Nation which he chaired.
By Monday morning February 27, Tugwell’s leak spread far and wide in the financial markets. The panic was on.
As Professors Nadler and Bogen noted in their classic 1933 history of the banking crisis, the “gold room” of the New York Federal Reserve Bank soon became a center of pandemonium: “As the panic week [February 27 to March 3] progressed, long lines formed to exchange ever larger amounts of gold there, until finally the metal was being carried away in large boxes and suitcases loaded on trucks.”
During the next five days approximately $800 million, or 20 percent, of the US gold stock was withdrawn by citizens, earmarked by foreign central banks, or implicitly purchased by speculators who took out a massive short position on the dollar. The lessons of the British default of September 1931 were still fresh, and as the smart money took aggressive actions to defend itself, the knock-on effect was almost instantly felt.
As Wall Street historian Barrie A. Wigmore noted in his magisterial history of the Great Depression, owing to the gold hemorrhage “the lender of last resort [i.e., the Fed] for the banking system was in doubt. Frightened depositors lined up for cash, the only working substitute for bank deposits.”
Wigmore’s point is dispositive. What financially literate citizens knew at the time, and was never grasped by postwar Keynesians, is that Federal Reserve currency notes were then required by statute to be backed by a 40 percent gold cover. The public therefore realized that only a few more days of the panicked gold drain could cause a sharp constriction of both the hand-to-hand currency supply and the banking system overall.
Accordingly, the daily currency figures provide ringing evidence of FDR’s culpability for the crisis. By February 23, the daily increase in currency outstanding had risen from the $8 million early February level to about $40 million, and then in the crisis week soared to nearly $200 million on Monday and hit $450 million on Friday, March 3, the day before the inauguration.
All told, the great bank teller window run and currency-hoarding crisis caused currency outstanding to rise from $5.6 billion to a peak of $7.5 billion. Yet $1.5 billion, or nearly 80 percent, of this gain occurred during the last ten days before FDR took office; that is, in the interval between the day Carter Glass said no and the morning FDR took the oath.
Barrie Wigmore’s work consists of seven hundred pages of massive documentation and only occasional viewpoints and judgments. But on the question of culpability for the banking crisis he left no doubt: “Roosevelt exacerbated the crisis. If he had handled the ‘lame duck’ period differently, there would have been no Bank Holiday … the banking system was unusually liquid prior to the bank crisis, and [the] recovery from it was unusually rapid … [proving] that the peculiar circumstances of Roosevelt’s transition were the cause of the crisis.”
Four days after FDR officially closed the nation’s 17,000 banking institutions, the Senate approved, after seventy-five minutes of debate and no written copy of the bill, the Emergency Banking Act, which empowered the secretary of the treasury “to re-open such banks as have already been ascertained to be in sound condition.”
But there was no New Deal magic in the bill at all. It had been drafted by Hoover holdovers and was a content-free enabling act which required no change whatsoever in bank procedures in order to obtain a li
cense to “reopen,” and included no standards for review or approval by the Treasury Department.
In fact, the legislation was the first of many FDR ruses. Once Hoover had been implicitly saddled with the blame for what appeared to be a frozen banking system and prostrate economy on March 4, FDR simply moved along to another topic, having had no intention of closing or reforming any banks. Accordingly, with such dispatch as would have made Internet-era number crunchers envious, the White House began opening banks the next Monday (March 13th), and by Wednesday 90 percent of the deposit basis among national banks had been reopened.
Within the following ten days nearly all of the $2 billion in hoarded currency had flowed back into the banking system, and the Fed’s gold reserves soon reached pre-crisis levels. By early April, fully 13,000 banks with $31 billion of deposits were open and more than 2,000 more quickly followed after they had been given RFC capital injections.
By contrast, at year-end 1933 only a thousand mostly tiny rural banks with aggregate deposits of less than $1 billion had been closed, thus demonstrating that at the time of FDR’s banking crisis only 3 percent of the nation’s bank deposits were still in insolvent institutions. In effect, the severe business cycle liquidation of the Great Depression was over even before Roosevelt was elected, and within weeks of his self-instigated banking crisis the US economy had resumed its natural rebound.
By June 1933, economic activity levels attained in the previous September had been regained and a slow upward climb ensued, led by the steady replenishment of fixed assets and working capital. To be sure, recovery was greatly attenuated by the shutdown of international trade, but in a process that was drawn and halting, nominal GDP eventually reached the $90 billion level by 1939. After seven years of New Deal medication, the nation’s money income was still straining to reach its 1929 level.
The Great Deformation Page 22