How Consumer Loans Saved the Banking Industry

In the past week, a flood of European capital into yield-less U.S. bonds reaffirmed a central problem of the economic crisis: a lack of good places to invest.

Safety, not profit, drives the allocation of capital today. Many banks are still reluctant to lend, and many prudent businesses fear borrowing or are hesitant to expand amid so much uncertainty. Companies willing to borrow, by their very eagerness, can appear dubious. This state of affairs is nothing new -- it was a hallmark of the Great Depression, and it offers some lessons for today’s bumpy recovery.

During the Depression, complaints were widespread that bankers refused to lend and were thus responsible for continued economic malaise. The New York Times and other newspapers ran headlines such as “Banks Fail to Find Sound Borrowers” and “Bank Loan Expansion Fails to Keep Pace.” Banks were “anxious to use idle funds” but few businesses that were considered good credit risks were borrowing.

National City Bank (the predecessor to Citigroup Inc.) and Bank of America provided a telling illustration. Both banks remained profitable, even while smaller ones across the country collapsed. Both had a great deal of cash. But they were struggling to find viable businesses that needed capital to expand.

Friendly Rivalry

National City Bank, which dominated New York, was headed by James H. Perkins. Bank of America, which dominated California, was led by Amadeo P. Giannini. Theirs was a friendly rivalry.

In March 1934, Perkins wrote to his friend and colleague “A.P.” in concern over the future of commercial banking. Although National City’s profits were still more than $1 million a month, Perkins noted, he feared that its solvency was going to be short-lived. “Our excess reserves are very big,” he wrote. “It is almost impossible to find any use for money in credits that we are willing to take, and the rates are terribly low.”

Perkins’s situation wasn’t unique. Banks across the country believed that there were no good customers. According to Perkins, their total excess reserves were more than $1 billion. Without an outlet for its funds, National City couldn’t continue to be profitable. Its fragile stability would falter.

Chairmen of national banks generally don’t concern one another over individual borrowers, but as the economy soured, even big executives spent time vying for small fish, and competition among the two friends soon became fierce. In 1935, Perkins and Giannini exchanged telegrams sparring for territory. Giannini complained to Perkins: “I understand that your man Banta has been unduly aggressive in soliciting some of our good borrowing accounts,” he wrote. “Such competition as between ourselves I am sure that in the long run we both will suffer.”

Disputes over potential customers such as the “Van Camp Sea Food Company” and “citrus associations” stood out among the men’s friendly exchanges about Florida holidays and New York restaurants, showing how bleak conditions were. By 1938, commercial lending at National City was “non-existent.”

What saved the banks during the Depression was not commercial lending but consumer lending. And the key was the newly created Federal Housing Administration, which began to guarantee loans for home purchases and improvements.

One of the men who set up the FHA’s lending programs, Roger Steffan, was actually loaned out from National City Bank. Speaking before the American Bankers Association 10 weeks after the program began in 1934, Steffan declared that it was “based on old-fashioned and orthodox principles -- to bring together private capital, industry and labor to do the long overdue job of brightening up American homes, at a fair profit.”

Expanding Credit

It worked. At the beginning of 1934, less than 1 percent of banks had a personal-loan department. By the end of that year, under the auspices of the FHA, more than 70 percent had started one. As bankers saw the profits from mortgage lending, they began offering more loans for other purposes. Excess capital that otherwise would go uninvested could now be employed.

Through “the example and the introduction of FHA modernization financing,” one banking journal noted, banks “established such departments through which almost every type of personal or installment financing” could then be arranged.

Like most other banks, Bank of America started its installment-loan department under the FHA’s insurance program. In 1935, it loaned $18 million. Giannini was so impressed with the profits that he vowed to expand the bank’s consumer lending even without government help.

The next year, Bank of America expanded the installment program to include cars, furniture and consumer durables through what it called the “Time Plan” financing system. The plan reaped tremendous profits -- the bank increased its earnings almost 40 percent in 1936, to $22.5 million.

In May 1937, Giannini told the Los Angeles Times that “the handling of these installment loans has trebled and quadrupled activity in our branches.” In the prior 18 months, he said, Bank of America had lent $140 million, expanded to 479 branches and added 5,400 employees. Consumer lending had attained maturity as a form of credit, even independent from the incubating FHA program.

Unfortunately, Perkins never saw National City Bank fully recover. He pushed himself to the limit during the Depression seeking to right one of America’s largest institutions and died in 1940, after ignoring his doctor’s recommendations for rest for many years.

Perkins’s dilemma wouldn’t be solved until the coming of World War II. His bank was rejuvenated by investment in the many new industries -- from aerospace to electronics -- that emerged in the expansive postwar economy.

Finding the best places to invest remains as much a challenge today as it was in the 1930s. As the bankers of that era would certainly remind us today, turning scared money into productive money is what ended the Depression, not just war. Bankers and policy makers would do well to remember that doing so requires, above all, innovation.

(Louis Hyman is an assistant professor of history at Cornell University and the author of “Borrow: The American Way of Debt.” The opinions expressed are his own.)

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