The Bank Panic and the Great Depression

While it is true that the stock market crash in October of 1929 was a major cause of the Great Depression, what really spread panic, fear and depression throughout the U.S. economy — and by extension the global economy — was not the collapse of America’s securities trading system, but the collapse of its banking system.  And to many historians that tailspin began this week (Dec. 11) in 1930 when New York’s Bank of the United States closed down.

But first the background.  Although unprecedented numbers of Americans had invested in the stock market by 1929, and therefore were devastated by its crash, the amount of money invested in stocks was nothing compared with the amount deposited in banks. Yet the banking system at the time was even more confusing and precarious than the trading system.

For one thing, there were more than 25,000 different banks in America in 1929, most of the “Mom and Pop” variety, and they were alarmingly undercapitalized.  Worse, as with the stock market, there were few uniform regulatory guidelines, constraints or protections. As a result, even in good times banks failed regularly, and because there was no such thing as branch banking, the small banks in rural communities — where their financial soundness often depended on the vagaries of agriculture — could not depend on better-funded central banks in metropolitan areas to rescue them in bad times.

Thus there was no financial “firewall” to protect against the spread of panic. A run on a bank, or banks, in one part of the country often spread to other parts.  Also, in order to preserve liquidity and attempt (usually in vain) to satisfy the withdrawal demands of their panicked customers, banks quickly sold off assets, thereby depressing their value and contributing to the deflationary spiral that marked the Great Depression.

This all came to a head when the Bank of the United States folded, and once again perception strangled reality.  The reality was that this Jewish-owned bank served mostly Jewish immigrants employed in New York’s garment trade.  In its way, it too was a “Mom and Pop” operation, although on a larger scale, but because it had such an august name, the Bank of the United States, and was located in New York City, its demise was perceived as signaling trouble in the major metropolitan banking system.  Thus the banking panic reached a much higher level, which helped bring on the Great Depression.

That, in turn, helped bring on Franklin Roosevelt’s victory in the 1932 presidential election, and it was with the banking crisis, and panic, clearly in mind that Roosevelt said in his Inaugural Address, “The only thing we have to fear is fear itself.”