The story

How Bank Failures Contributed to the Great Depression


On the surface, everything was hunky-dory in the summer of 1929. The total wealth of the United States had almost doubled during the Roaring Twenties, fueled, in part, by stock market speculation eagerly undertaken by a wide swath of citizens ranging from Fifth Avenue dowagers to factory workers. One Midwestern woman, a farmer, made an overnight profit of $2,000 ($31,000 in today’s dollars) betting on a car manufacturer’s stock.

When the bubble burst in spectacular fashion in October 1929, many economists, including John Kenneth Galbraith, author of The Great Crash 1929, blamed the worldwide, decade-long Great Depression that followed on all those reckless speculators. Most saw the banks as victims, not culprits.

The reality is more complex. Sure, without all that uncontrolled and irrational market speculation, the 1930s might be recalled simply as a period when the economy and prosperity stalled. But just why—and how—could those gamblers dominate the stock market? And why did a crisis in the markets become a systemic decade-long economic catastrophe during which unemployment skyrocketed to 25 percent and the cost of goods and services plunged? By 1933, dozen eggs cost only 13 cents, down from 50 cents in 1929. Banks failed—between a third and half of all U.S. financial institutions collapsed, wiping out the lifetime savings of millions of Americans.

The familiar narrative of the Great Depression places banks among the institutions that suffered fallout from the crisis. In fact, in the eyes of such luminaries as Ben Bernanke, an economic historian and former head of the Federal Reserve, the crisis was all about the banks—from the central bank (the Fed itself), down to the smallest savings institutions. “Regarding the Great Depression…we did it,” Bernanke said in a 2002 speech, referring primarily to the Fed’s role. “We’re sorry.”

Here are four ways banks "did it":

Banks Extended Too Much Credit

The runaway speculation that triggered the 1929 crash and the Great Depression that followed couldn’t have taken place without the banks, which fueled the 1920s credit boom. New businesses—making new products like automobiles, radios and refrigerators—borrowed to support non-stop expansion in output. They kept borrowing and spending even as business inventories soared (300 percent between 1928 and 1929 alone) and Americans’ wages stagnated. The banks, ignoring the warnings signs, kept subsidizing them.

The banks also funded the speculation itself, providing the money that individual investors needed to buy stocks on margin. That Midwestern farmer might have borrowed up to 90 percent of the money she needed to make her overnight killing on the automobile stock, financed by her local bank. Bank lenders discounted or downplayed growing signs that Americans were overstretched. Farm incomes, in particular, plunged in the years leading up to 1929, and others found their wages stagnant. Their prosperity came solely from their stock market wealth—which didn’t last.

READ MORE: Why the Roaring Twenties Left Many Americans Poorer

Banks Ignored the Federal Reserve

The Fed, which serves as America’s central bank, did try to rein things in, albeit too slowly and too late in the game. It sent warning letters to the banks to which the Fed itself provided credit, warning them to take their collective feet off the gas pedals. Banks, with their eyes firmly fixed on the “easy” profits to be earned by funding speculation, paid little attention. After all, wasn’t it a virtuous cycle? The more investment profits their customers generated, the more money they would have to spend on new homes or consumer goods. Why worry? By the time the Fed slammed on the brakes by raising interest rates in 1929, it was too late to stem the crash, or the fallout on the banks.

WATCH: Full Episodes of The Titans That Built America online now.

Banks Didn’t Maintain Adequate Reserves

It sounds kind of geeky, but one of the ways that banks contribute to the health of the economy—and help avoid catastrophes like the Great Depression—is to manage their cash reserves. Typically, banks hold onto only a small percentage of all the money depositors entrust to them, and lend out the rest in search of a profit; that’s how they make their money. In ordinary times, banks count on the ability to borrow from other financial institutions, or from the Federal Reserve, to cover any unexpected shortfall in reserves if their customers start showing up in droves and demanding their deposits back. During the Depression, the pressure on those backup providers of capital proved unsustainable; moreover, large numbers of American banks hadn’t joined the Federal Reserve system and so weren’t able to tap its reserves to avoid collapse.

It wasn’t until the stock market crashed and fearful Americans flocked to banks to demand their cash—so they could stow it under the mattress or use it to offset their massive stock market losses—that banks realized what they’d done. They hadn’t kept enough reserves on hand to address the growing risks associated with runaway credit and speculation.

Ironically, once banks started to try to correct their missteps, they made the problem worse. When banks sought to protect themselves, they stopped lending money. Businesses couldn’t get access to capital, and closed their doors, throwing millions of Americans out of work. Those unemployed Americans couldn’t keep spending, and the toxic downward spiral continued. As bank after bank collapsed, it wasn’t just savings that were lost, but information: Surviving institutions had no way to gauge which companies or individuals were good credit risks.

READ MORE: What Caused the Stock Market Crash of 1929?

Banks Needed Fixing

If banks led to the crash and the subsequent economic crisis that extended into the Great Depression, then they needed to be fixed in order for the economy to begin to recover. By 1933, the wave of bank failures was stemmed by the decision of the newly elected president, Franklin D. Roosevelt, to declare a four-day banking “holiday” while Congress debated and passed the Emergency Banking Act, which formed the basis of the 1933 Banking Act, or Glass-Steagall Act. For their part, legislators required banks to join the Federal Reserve system and approved the creation of deposit insurance, so that future bank failures couldn’t wreak havoc on family savings. They also took steps to curb speculation by banning commercial lenders from dabbling in the stock market. Even before Roosevelt signed the new measures into law, Americans began returning hoarded cash to surviving banks. The banking system had been saved, even though it would take years for the economy itself to climb out of the deep hole of the Depression.


How Bank Failures Contributed to the Great Depression - HISTORY

As the economic depression deepened in the early 30s, and as farmers had less and less money to spend in town, banks began to fail at alarming rates. During the 20s, there was an average of 70 banks failing each year nationally. After the crash during the first 10 months of 1930, 744 banks failed – 10 times as many. In all, 9,000 banks failed during the decade of the 30s. It's estimated that 4,000 banks failed during the one year of 1933 alone. By 1933, depositors saw $140 billion disappear through bank failures.

Gresham, Nebraska, had two banks – one too many for that small town. The bank in danger of failure merged with the other. Gresham resident Walter Schmitt (right) remembers the deadly consequences for the owner of the failed bank.

When a new president, Franklin Delano Roosevelt was inaugurated in March 1933, banks in all 48 states had either closed or had placed restrictions on how much money depositors could withdraw. FDR's first act as President was to declare a national "bank holiday" – closing the banks for a three-day cooling off period. The most memorable line from the President's speech was directed to the bank crisis – "The only thing we have to fear is fear itself."

Some economists and historians have argued that the bank crisis caused the Great Depression. But others have looked at fundamental economic factors and regional histories and argued that banks failed as a result of the economic collapse.

Whether the fear of bank failures caused the Depression or the Depression caused banks to fail, the result was the same for people who had their life savings in the banks – they lost their money. At the beginning of the 30s, there was no such thing as deposit insurance. If a bank failed, you lost the money you had in the bank. Carla Due's family experienced the fear that a bank failure would wipe out savings.

Birdie Farr's (left) father-in-law, Jack Farr, lost his savings in a Grand Island bank, but he was philosophical about it. Birdie says, "There wasn't nothing for him to do. He said, 'Standing there crying isn't going to help.'"

Louise Dougherty's (right) father owned a bank in Perkins County. When the Depression hit, he worked hard to keep the bank afloat. But the Depression went on too long, and eventually he was forced to go out of business.

Written by Bill Ganzel of the Ganzel Group. First written and published in 2003.


Banks Ignored the Federal Reserve

The Fed, which serves as America’s central bank, did try to rein things in, albeit too slowly and too late in the game. It sent warning letters to the banks to which the Fed itself provided credit, warning them to take their collective feet off the gas pedals. Banks, with their eyes firmly fixed on the “easy” profits to be earned by funding speculation, paid little attention. After all, wasn’t it a virtuous cycle? The more investment profits their customers generated, the more money they would have to spend on new homes or consumer goods. Why worry? By the time the Fed slammed on the brakes by raising interest rates in 1929, it was too late to stem the crash, or the fallout on the banks.

WATCH: The 3-night event, ‘The Titans That Built America,’ premiering Memorial Day at 9/8c. Watch a preview now:


Banks Needed Fixing

If banks led to the crash and the subsequent economic crisis that extended into the Great Depression, then they needed to be fixed in order for the economy to begin to recover. By 1933, the wave of bank failures was stemmed by the decision of the newly elected president, Franklin D. Roosevelt, to declare a four-day banking “holiday” while Congress debated and passed the Emergency Banking Act, which formed the basis of the 1933 Banking Act, or Glass-Steagall Act. For their part, legislators required banks to join the Federal Reserve system and approved the creation of deposit insurance, so that future bank failures couldn’t wreak havoc on family savings. They also took steps to curb speculation by banning commercial lenders from dabbling in the stock market. Even before Roosevelt signed the new measures into law, Americans began returning hoarded cash to surviving banks. The banking system had been saved, even though it would take years for the economy itself to climb out of the deep hole of the Depression.


Bank Failures During The Great Depression

Economists can debate whether bank failures caused the Great Depression, or the Great Depression caused bank failures, but this much is undisputed: By 1933, 11,000 of the nation’s 25,000 banks had disappeared.

The run on America’s banks began immediately following the stock market crash of 1929. Overnight, hundreds of thousands of customers began to withdraw their deposits. With no money to lend and loans going sour as businesses and farmers went belly up, the American banking crisis deepened.

After taking office in March 1933, Franklin D. Roosevelt did his best to shore up the flagging banking system. When a third banking panic in less than four years threatened, he announced a three-day bank holiday to stop the run on banks by halting all financial transactions. When the banks were allowed to reopen, nearly 1,000 banks had been saved.

On January 1, 1934, the Federal Deposit Insurance Corporation (FDIC) was established, and since that time, not one depositor has lost insured funds.

Prior to the fall of 2008, FDIC insured bank accounts up to $100,000. The Bush Administration changed those levels to $250,000.


EconProph

From the FDIC (Federal Deposit Insurance Corp.) itself, a great brief history of banking failures in the 1920’s and the Great Depression. see: FDIC: Managing the Crisis: The FDIC and RTC Experience.

On average, more than 600 banks failed each year between 1921 and 1929. Those failures led to the end of many state deposit insurance programs. The failed banks were primarily small, rural banks, and people in metropolitan areas were generally unconcerned. Investors and other businessmen thought that the failing institutions were weak and badly managed and that those failures served to strengthen the banking system. A major wave of bank failures during the last few months of 1930 triggered widespread attempts to convert deposits to cash. Confidence in the banking system began to erode, and bank runs became more common. In all, 1,350 banks suspended operations during 1930. Some simply closed their doors due to financial difficulties, while others were placed into receivership.

To begin to understand both the severity of the crisis and the impact it had on everyday Americans, it is necessary to try to come to grips with its magnitude. In the four years of 1930-1933 alone, nearly 10,000 banks failed or were suspended. These banks held deposits of over $6.8 billion (equivalent to perhaps $60 billion today’s dollars, but representing a much larger share of depositor’s wealth then). The depositors in these banks lost nearly 20% of these deposits when the banks failed. Since there was no FDIC yet, and most state deposit insurance schemes had shut down already, this meant that everyday folks lost their savings, their money. Imagine that impact. You’ve worked hard. Saved money to buy a house on one of those shiny new Ford Model A’s or a Chevrolet. Then one day, your money is just gone. Disappeared. It’s a life-changing event for many of those depositors. But then consider that the monies lost by these unfortunate bank customers represented (over the 4 years) approximately 4% of ALL DEPOSITS at ALL BANKS. Even those fortunate (or lucky) enough to have their money in a sound bank would be scared. Were they next? With the Hoover administration and The Federal Reserve seemingly doing nothing to slow the accelerating trend of bank failures, it is no wonder that FDR won a landslide election in 1932 and that a bank holiday and bank reforms were job #1 of his New Deal.

Details in the table after the

There’s also this table of the failures and losses during each year of this period.


Protecting Your Cash

It is important to keep an eye on this situation as it unfolds to be sure your deposits are safe. But the most important step you can take is to be sure all of your bank deposits are protected by FDIC insurance. As of this writing, every individual and business depositor at a FDIC member bank is insured up to $250,000 by FDIC insurance. This insurance is backed by the full faith and credit of the U.S. Government.

Protection for more than $250,000

If you’re fortunate enough to have more than $250k in cash for yourself or your business, you should be careful not to keep it all at the same bank. FDIC insurance only covers your cash up to the $250k limit per investor, per depository institution. This means that you can spread your money among many different banks to achieve FDIC protection on every penny. However, this creates a lot of work in managing multiple banking relationships, statements and reconciliations.

Thankfully, financial technology [fintech] has a solution. The American Deposit Management company has developed proprietary fintech that allows you to spread your cash among their network of hundreds of community banks to virtually unlimited FDIC coverage for your business cash. The best part is this all happens with a 10-minute application, a single deposit, and a single unified monthly statement. Our Marketplace Banking™ accounts also provide next-day liquidity on top of the MOST safety you can get for your cash. You get this all while keeping your current bank. It’s important for you to know that we’re not here to replace your bank, we’re here to enhance it.

If you need the MOST protection for your business deposits, don’t hesitate to contact a member of our team. Our team is our secret sauce and we’ll get your business on the road to the MOST protection and the MOST competitive return available for your cash.


Causes of the Great Depression

The Great Depression of the late 1920s and ’30s remains the longest and most severe economic downturn in modern history. Lasting almost 10 years (from late 1929 until about 1939) and affecting nearly every country in the world, it was marked by steep declines in industrial production and in prices (deflation), mass unemployment, banking panics, and sharp increases in rates of poverty and homelessness. In the United States, where the effects of the depression were generally worst, between 1929 and 1933 industrial production fell nearly 47 percent, gross domestic product (GDP) declined by 30 percent, and unemployment reached more than 20 percent. By comparison, during the Great Recession of 2007–09, the second largest economic downturn in U.S. history, GDP declined by 4.3 percent, and unemployment reached slightly less than 10 percent.

There is no consensus among economists and historians regarding the exact causes of the Great Depression. However, many scholars agree that at least the following four factors played a role.

The stock market crash of 1929. During the 1920s the U.S. stock market underwent a historic expansion. As stock prices rose to unprecedented levels, investing in the stock market came to be seen as an easy way to make money, and even people of ordinary means used much of their disposable income or even mortgaged their homes to buy stock. By the end of the decade hundreds of millions of shares were being carried on margin, meaning that their purchase price was financed with loans to be repaid with profits generated from ever-increasing share prices. Once prices began their inevitable decline in October 1929, millions of overextended shareholders fell into a panic and rushed to liquidate their holdings, exacerbating the decline and engendering further panic. Between September and November, stock prices fell 33 percent. The result was a profound psychological shock and a loss of confidence in the economy among both consumers and businesses. Accordingly, consumer spending, especially on durable goods, and business investment were drastically curtailed, leading to reduced industrial output and job losses, which further reduced spending and investment.

Banking panics and monetary contraction. Between 1930 and 1932 the United States experienced four extended banking panics, during which large numbers of bank customers, fearful of their bank’s solvency, simultaneously attempted to withdraw their deposits in cash. Ironically, the frequent effect of a banking panic is to bring about the very crisis that panicked customers aim to protect themselves against: even financially healthy banks can be ruined by a large panic. By 1933 one-fifth of the banks in existence in 1930 had failed, leading the new Franklin D. Roosevelt administration to declare a four-day “bank holiday” (later extended by three days), during which all of the country’s banks remained closed until they could prove their solvency to government inspectors. The natural consequence of widespread bank failures was to decrease consumer spending and business investment, because there were fewer banks to lend money. There was also less money to lend, partly because people were hoarding it in the form of cash. According to some scholars, that problem was exacerbated by the Federal Reserve, which raised interest rates (further depressing lending) and deliberately reduced the money supply in the belief that doing so was necessary to maintain the gold standard (see below), by which the U.S. and many other countries had tied the value of their currencies to a fixed amount of gold. The reduced money supply in turn reduced prices, which further discouraged lending and investment (because people feared that future wages and profits would not be sufficient to cover loan payments).

The gold standard. Whatever its effects on the money supply in the United States, the gold standard unquestionably played a role in the spread of the Great Depression from the United States to other countries. As the United States experienced declining output and deflation, it tended to run a trade surplus with other countries because Americans were buying fewer imported goods, while American exports were relatively cheap. Such imbalances gave rise to significant foreign gold outflows to the United States, which in turn threatened to devalue the currencies of the countries whose gold reserves had been depleted. Accordingly, foreign central banks attempted to counteract the trade imbalance by raising their interest rates, which had the effect of reducing output and prices and increasing unemployment in their countries. The resulting international economic decline, especially in Europe, was nearly as bad as that in the United States.

Decreased international lending and tariffs. In the late 1920s, while the U.S. economy was still expanding, lending by U.S. banks to foreign countries fell, partly because of relatively high U.S. interest rates. The drop-off contributed to contractionary effects in some borrower countries, particularly Germany, Argentina, and Brazil, whose economies entered a downturn even before the beginning of the Great Depression in the United States. Meanwhile, American agricultural interests, suffering because of overproduction and increased competition from European and other agricultural producers, lobbied Congress for passage of new tariffs on agricultural imports. Congress eventually adopted broad legislation, the Smoot-Hawley Tariff Act (1930), that imposed steep tariffs (averaging 20 percent) on a wide range of agricultural and industrial products. The legislation naturally provoked retaliatory measures by several other countries, the cumulative effect of which was declining output in several countries and a reduction in global trade.

Just as there is no general agreement about the causes of the Great Depression, there is no consensus about the sources of recovery, though, again, a few factors played an obvious role. In general, countries that abandoned the gold standard or devalued their currencies or otherwise increased their money supply recovered first (Britain abandoned the gold standard in 1931, and the United States effectively devalued its currency in 1933). Fiscal expansion, in the form of New Deal jobs and social welfare programs and increased defense spending during the onset of World War II, presumably also played a role by increasing consumers’ income and aggregate demand, but the importance of this factor is a matter of debate among scholars.


Bank Failures in Theory and History: The Great Depression and Other "Contagious" Events

Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or "contagion" played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.

This paper was prepared for the Oxford Handbook of Banking, edited by Allen Berger, Phil Molyneux, and John Wilson. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.


Deflation increased the real burden of debt and left many firms and households with too little income to repay their loans. Bankruptcies and defaults increased, which caused thousands of banks to fail. In each year from 1930 to 1933, more than 1,000 U.S. banks closed.

How does bank capital help prevent bank failure? Bank failure: a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements . Holding adequate bank capital helps prevent bank failures because it can be used to absorb the losses resulting from a deposit outflow.

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