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Banking Panics (1930–1933)

BANKING PANICS (1930–1933)

More than nine thousand banks failed in the United States between 1930 and 1933, equal to some 30 percent of the total number of banks in existence at the end of 1929. This statistic clearly represents the highest concentration of bank suspensions in the nation's history. The data reveal at least four separate intervals when there was a marked acceleration and deceleration in the number of bank failures: November 1930 to January 1931, April to August 1931, September and October 1931, and February and March 1933. Milton Friedman and Anna Schwartz designated these four episodes as banking panics, only one of which had causal macroeconomic significance. If the 3,400 banks that were not licensed by the Secretary of the Treasury to reopen in March 1933 are excluded, only two out of five bank suspensions occurred during banking panics. It is well to bear in mind that 60 percent of bank closings between 1930 and 1932 were not panic induced and that the problem of understanding why so many banks failed during the Great Depression goes beyond simply explaining what happened during banking panics. For example, one of the causes of the nonpanic-induced failures during the Great Depression may have been related in part to the over expansion of small, rural banks in the twenties as well as to the distressed state of American agriculture following World War I. These factors may have operated during banking panics as well but would have by no means been confined to panic episodes.

Unlike previous banking panics of the national banking era, the banking panics of the Great Depression occurred during the same cyclical contraction from 1929 to 1933, each compounding the effects generated in the previous panic.

DEFINITION AND CHARACTERISTICS OF BANKING PANICS

A banking panic may be defined as a class of financial shocks whose origin can be found in any sudden and unanticipated revision of expectations of deposit loss and during which there is an attempt, usually unsuccessful, to convert checkable deposits into currency. There are two principal characteristics of banking panics: an increased number of bank runs and bank suspensions and currency hoarding as measured by the amount of Federal Reserve notes in circulation seasonally adjusted. Table 1 shows the number of bank suspensions, amount of hoarding, and panic severity in each of the panics of the Great Depression, 1933 excepted. Panic severity is measured by the number of bank suspensions in each panic divided by the total number of banks in existence.

BANKING PANIC OF 1930

During the banking panic of 1930, over eight hundred banks closed their doors between November 1930 and January 1931, and Federal Reserve notes in circulation seasonally adjusted increased by $164 million, or 12 percent (see table). The largest number of bank closings was concentrated in the St. Louis Federal Reserve District with approximately two suspensions out of every five banks. These closings were related to the failure of the largest regional investment banking house in the South, Caldwell and Co. of Nashville, Tennessee. The firm controlled the largest chain of banks in the South with assets in excess of $200 million and also the largest insurance group in the region with assets

Number of Bank Suspensions, Domestic Hoarding, and Panic Severity
(in Millions of Dollars)
Panic Dates Suspensions Domestic Hoarding Panic Severity
Nov. 1930-Jan. 1931 806 164 3.4
April-Aug. 1931 573 348 2.95
Sept.-Oct 1931 827 270 4.27
Feb.-Mar. 1933 Bank Holidays 1502  

of $240 million. The failure of Caldwell and Co. had immediate repercussions in four states: Tennessee, Kentucky, Arkansas, and North Carolina. The collapse of Caldwell's financial empire raised expectations of deposit loss throughout the surrounding region. The 1930 panic was region specific, inasmuch as at least one-half of the twelve Federal Reserve Districts had fewer than 10 percent of bank suspensions. Four Districts accounted for 80 percent of total bank suspensions and slightly over one-half of the deposits of suspended banks. The consensus view in the early twenty-first century was that the 1930 banking crisis was a region specific crisis without perceptible national economic effects.

THE TWO BANKING PANICS OF 1931

No more than two months elapsed between the end of the first banking crisis in January 1931 and the onset of the second in April. The number of bank suspensions was lower (573), but the amount of hoarding doubled. One-third of the bank suspensions were in the Chicago Federal Reserve District; there was a mini panic in Chicago in June and a full scale panic in Toledo, Ohio, in August. The Cleveland Federal Reserve District had two-thirds of the deposits of suspended banks. Nevertheless, in six Districts there was little or no change in currency hoarding.

The onset of the third banking panic coincided with Britain's departure from the gold standard in September 1931. Bank failures, deposits of failed banks, and hoarding rapidly accelerated after the British announcement. The immediate response of the Federal Reserve was to raise the discount rate in October 1931; this action was followed by an increase in interest rates. The harmful effects of the increase may have been exaggerated since increased bank suspensions and hoarding had preceded the increase. Mini panics in Pittsburgh, Philadelphia, and Chicago with their reverberating effects occurred between September 21 and October 9, before the discount rate was increased. Sixty percent of the increase in hoarding occurred before the rate increase. The discount rate increase played no causal role in precipitating the panic. Nor did the Fed's failure to offset the decline in the money stock represent ineptitude. Knowledge of the role of the currency-deposit ratio as a determinant of the money stock was simply unavailable. In sum, 60 percent of the 2,291 bank closings in 1931 occurred during the two separate banking panics.

THE BANKING PANIC OF 1933

The 1933 panic was idiosyncratic. In no other financial panic was there such a widespread use of the legal device of the "bank holiday," whereby a state official, usually the governor, closed all of the banks for a short time. In March 1933 one of the first acts of Franklin Roosevelt, the incoming president, was to announce a nationwide banking holiday, an event without precedent in U.S. history. Prior to Roosevelt's action many states had declared their own bank holidays. Such action was the mechanism through which depositor confidence was further eroded and was spread to contiguous states. Officials in the individual states panicked. Uncoordinated state initiatives led to a nationwide banking debacle. The use of statewide moratoria was not new. Five states had declared banking holidays during the 1907 panic. What was new was its use by the president.

The timing of the national banking holiday was dictated by two considerations simultaneously. First, a banking system had virtually collapsed without any prospects for recovery in the absence of national leadership. The outgoing president, Herbert Hoover, and the Federal Reserve had abdicated their responsibility for what was happening. Second, an external drain of gold allegedly threatened gold convertibility of the dollar.

CAUSES OF BANKING PANICS

The importance of banking panics for understanding the Great Depression resides in determining their causal significance. Did bank failures cause the decline in income and interest rates or did the decline in income and interest rates cause bank failures? To have exerted a causal role, panic-induced bank suspensions would have had to be independent of interest rate and income changes. Friedman and Schwartz assigned a causal role to bank suspensions in order to explain why the money stock fell; an autonomous increase in the currency-deposit ratio, a money stock determinant, provoked a rash of bank suspensions that caused the money stock to contract, income to decline, and the conversion of a mild recession into a major depression. James Boughton and Elmus Wicker, in 1979 and 1984, showed that interest rates and income were, in fact, important determinants of the money stock. Their finding that the currency-deposit ratio was sensitive to interest rate and income changes is consistent with Peter Temin's view that causation went from income and interest rates to the money stock and not vice versa. As of the early twenty-first century, a consensus was slowly emerging that panic-induced bank suspensions were not causally significant.

Why, people may ask, were there any banking panics at all? Had not the Federal Reserve been established to eliminate banking panics? Yet the worst banking panics in U.S. history occurred thereafter. How was that possible? Did the fault lie in imperfect legislation creating the Fed or was Fed leadership culpable? Friedman and Schwartz attributed panics to inept Fed leadership. But they rejected a compelling alternative explanation that deserves serious reconsideration. Structural weaknesses in the original Federal Reserve Act can explain equally well, if not better, why the Fed failed to prevent the panics of the Great Depression. There were at least three important structural weaknesses in the original Federal Reserve Act: 1) membership was not compulsory for state bank and trust companies, 2) paper eligible for discount by member banks was too narrowly defined and restricted access to the Fed, and 3) power was so decentralized between the twelve Federal Reserve Banks and the Board in Washington that leadership was weak and ineffective. These combined structural weaknesses contributed to the Fed's poor performance.

EMERGENCY BANKING ACT OF 1933

The Emergency Banking Act of March 9, 1933, granted the government the necessary powers to reopen the banks and to resolve the immediate banking crisis. Only one-half of the nation's banks with 90 percent of the total U.S. banking resources were judged capable of doing business on March 15; these banks were presumably safe, meaning that they were solvent. The other half remained unlicensed. Forty-five percent of those were placed under the direction of "conservators" whose function it was to reorganize the banks for the purpose of eventually returning to solvency. The remaining 5 percent (about 1,000) would be closed permanently. The reopening of the banks on March 13 witnessed a return flow of currency into the banks for first time since the banking panic of 1930. By April 12, some 12,817 banks had been licensed to open with $31 billion of deposits.

See Also:FEDERAL RESERVE SYSTEM; GLASS-STEAGALL ACT OF 1933; MONETARY POLICY.

BIBLIOGRAPHY

Boughton, James, and Elmus Wicker. "The Behavior of the Currency-Deposit Ratio during the Great Depression." Journal of Money, Credit, and Banking. L 1 (1979): 405–418.

Boughton, James, and Elmus Wicker. "A Reply to Trescott." Journal of Money, Credit, and Banking. 16 (1984): 336–337.

Friedman, Milton, and Anna Schwartz. A Monetary History of the United States 1867–1960. 1963.

Temin, Peter. Did Monetary Forces Cause the Great Depression? 1976.

Wicker, Elmus. The Banking Panics of the Great Depression. 1996.

Elmus Wicker

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