In 1929, there were nearly 25,000 banks in the U.S. Many European nations had fewer than 100. More than 90 percent of U.S. banks served small towns and rural districts, held state charters and hadn't joined the Federal Reserve System (which was mandatory for nationally chartered banks). Thus they couldn't seek loans from the Fed to support liquidity.
Given that deposits were uninsured, "runs" commenced when rumors circulated that a bank was having difficulty collecting mortgage and loan payments. Accountholders lined up hoping to recover their savings or liquidate their checking accounts. Banks often responded by limiting payouts or requiring, say, 30 days' notice for withdrawals. Fears of being "wiped out" spread and deepened, credit dried up, closures multiplied.
About 800 banks closed their doors in late 1930, and more than 1,500 in 1931.
In the fall of that year, President Herbert Hoover's administration tried a voluntarist way to address the erosion of confidence. Treasury Secretary Andrew Mellon secured a pledge of $500 million from a group of major New York banks as a basis for the National Credit Corporation, which would make loans to smaller banks in danger of collapse. This failed, however, as the NCC's managers proved reluctant to take risks; they loaned out only between $10 million and $20 million, a trickle given the impending crisis.
In December, plans for a new federal agency to intervene in the crisis were drawn up quickly, under pressure from Federal Reserve Chairman Eugene Meyer. The result was the Reconstruction Finance Corporation, an independent agency that would be funded by the issuance of $2 billion in federal bonds and would issue loans to stabilize the financial system. Attempts to have the agency also assist cities failed.
On Jan. 22, 1932, Hoover signed the bill and promptly appointed Charles G. Dawes, the banker and former vice president, as its head. Hopes rose for extensive efforts to re-fund and rescue closed banks, facilitate agricultural exports and shore up endangered financial companies by establishing “a mobile reservoir of credit," as Mellon’s successor Owen Mills put it, and "an adequate guarantee against unforeseen contingencies." Mills added that the policy was “designed to free rather than create credit,” and counted on private institutions to emulate the agency and increase loan activity.
He quoted Walter Bagehot’s classic, “Lombard Street: A Description of the Money Market," approvingly. "The best way for the bank … to deal with a drain arising from internal discredit," Bagehot wrote, "is to lend freely."
On Jan. 23, The Economist cautioned that omitting cities from the program could be disastrous. “American municipal finance is in a parlous state, largely because the task of providing for the unemployed is left in the main to the great American cities,” it said. Chicago, Philadelphia and New York were facing bankruptcy. “It is clear," the newspaper added, "that the American governmental and social structure is ill-equipped to deal with an economic and unemployment crisis of the present magnitude.”
(Philip Scranton is a Board of Governors Professor of the History of Industry and Technology at the University of Rutgers at Camden and the editor-in-chief of Enterprise and Society. He writes "This Week in the Great Depression" for the Echoes blog. The opinions expressed are his own.)
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