In the fall of 1930, the economy seemed poised for recovery. the three previous contractions, in 1920, 1923, and 1926, had lasted an average of fifteen months.1 the recession that began in the summer of 1929 had lasted fifteen months. a quick and robust recovery was expected. In November 1930, however, a series of crises among commercial banks turned what had been a typical recession into the beginning of the Great Depression.
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When the crises began, more than 8,000 commercial banks were in the Federal Reserve System, but almost 16,000 were not. Those nonmember banks operated in an environment similar to the one that existed before the Federal Reserve was established in 1914. That environment harbored the causes of banking crises.
One cause was the practice of counting checks in the process of collection as part of banks’ cash reserves. These ‘floating’ checks were counted in the reserves of two banks, the one in which the check was deposited and the one on which the check was drawn.2 In reality, however, the cash resided in only one bank. Bankers at the time referred to the reserves composed of float as fictitious reserves. The quantity of fictitious reserves rose throughout the 1920s and peaked just before the financial crisis in 1930. This meant that the banking system as a whole had fewer cash (or real) reserves available in emergencies (Richardson 2007).
Another problem was the inability to mobilize bank reserves in times of crisis. non-member banks kept a portion of their reserves as cash in their vaults and most of their reserves as deposits at correspondent banks in designated cities. many, but not all, of the final correspondents were from the Federal Reserve System. this reserve pyramid limited the countries’ banks’ access to reserves during times of crisis.3 When a bank needed cash, because its customers panicked and withdrew funds en masse, the bank had to turn to its correspondent, who it could face requests from many banks simultaneously or it could be beset by runs from depositors. The correspondent bank might also not have the funds available because its reserves consisted of checks sent through the mail, rather than cash in its vault. if so, the correspondent would, in turn, have to request reserves from another correspondent bank. that bank, in turn, may not have available reserves or may not respond to the request.4
These problems turned the collapse of Caldwell and Company into a painful financial event. Caldwell was a rapidly expanding conglomerate and the largest financial holding company in the South. It provided its clients with a variety of services (banking, brokerage, insurance) through an expanding chain controlled by its parent company based in Nashville, Tennessee. The parent company ran into trouble when its leaders invested too much in the stock markets and lost substantial sums when share prices fell. To cover their own losses, the leaders siphoned cash from the corporations they controlled.
on november 7, one of caldwell’s main subsidiaries, the bank of tennessee (nashville) closed its doors. On November 12 and 17, Caldwell’s subsidiaries in Knoxville, Tennessee, and Louisville, Kentucky, also went bankrupt. the bankruptcies of these institutions triggered a cascade of correspondents that forced dozens of commercial banks to suspend their operations. In communities where these banks closed, depositors panicked and withdrew funds en masse from other banks. panic spread from town to town. within a few weeks, hundreds of banks suspended their operations. about a third of these organizations reopened within a few months, but most were liquidated (richardson 2007).
The panic began to subside in early December. But on December 11, the fourth largest bank in New York City, the Bank of the United States, ceased operations. the bank had been negotiating to merge with another institution. The New York Fed had helped with the search for a merger partner. When negotiations failed, depositors rushed to withdraw funds and the New York Superintendent of Banks closed the institution. This event, like the Caldwell collapse, generated headlines across the United States, fueling fears of financial panics and currency shortages like the Panic of 1907 and prompting nervous depositors to withdraw funds from other banks.
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The Federal Reserve’s reaction to this crisis varied by district. The crisis began in the Sixth Ward, based in Atlanta. The leaders of the Federal Reserve Bank of Atlanta believed that its responsibility as a lender of last resort extended to the banking system as a whole. Atlanta fed expedited discount loans to member banks, encouraged member banks to make loans to their nonmember respondents, and quickly sent funds to cities and towns plagued by bank runs.5
The crisis also hit the 8th district, based in st. louis the leaders of the federal reserve bank of st. Louis had a more limited view of his responsibilities and refused to rediscount loans in order to accommodate non-member banks. during the crisis, the st. louis fed limited discount loans and refused to help non-member institutions.
results differed between districts. After the crisis, in the 6th district, the economic contraction slowed down and recovery began. in the eighth district, hundreds of banks failed. loans decreased. business faltered and unemployment rose (richardson and troost 2009; jalil 2014; ziebarth 2013).
The banking crisis that began with the Caldwell collapse died down in early 1931. A new crisis broke out in June 1931, this time in the city of Chicago. once again, depositor flows beset networks of non-member banks, some of which had invested in assets that had fallen in value. In Chicago, the problem particularly involved real estate.