Elmus Wicker, Indiana University
Prior to the passage of deposit insurance legislation in 1933 banking panics were a recurrent feature of U.S. banking history. Three phases of that panic experience can be identified depending upon the type of regulatory framework in place: the pre-Civil War era, the National Banking era, and the era of the Federal Reserve System. Federal regulation was absent in the antebellum period with panics in 1819, 1837, 1857 and incipient panics in 1860 and 1861. During the National Banking era, banking panics occurred in 1873, 1893, and 1907 with incipient panics in 1884 and 1890. After the Federal Reserve Act was passed in 1913, there were four full-scale banking panics, one in 1930, two in 1931, one in 1933 and a localized panic in Chicago in 1932. This article will examine post-Civil War banking panics only.
Panics as Financial Shocks
Banking panics belong to a general class of financial shocks, which include panics in the stock market, the foreign exchange market and the acceleration of commercial bankruptcies. Banking panics are only one type of financial shock and certainly not the most frequent.
A banking panic may be defined as a class of financial shocks whose origin can be found in any sudden and unanticipated revision of expectations of deposit loss where there is an attempt, usually unsuccessful, to convert checking deposits into currency. In the past banking panics were regarded as examples of irrational or inscrutable behavior. That has changed. More recently they have been treated as a rational depositor response to an asymmetric information deficit. This revival of interest in banking panic theory has renewed scholarly interest in what happened in specific panic episodes.
Banking panics may be local, regional or national in geographical incidence. However, that does not preclude the economic effects from being extended beyond local or regional boundaries. With the single exception of the 1893 panic, pre-1914 banking panics were restricted mainly to the New York money market with relatively few bank suspensions in the rest of the country. Yet there were nonnegligible national effects in some instances on the money stock. Effects of panics on expenditures and overall economic activity have been more difficult to measure.
Specific banking panics differed as to their origins, duration, the number and incidence of bank runs and bank failures, the response of the New York Clearing House (NYCH) in the earlier period and the Federal Reserve in the latter, and their real effects, if any. Each had its own signature, as it were, differentiating it from the others. With due respect to the differences one can attempt to construct a general profile of the panics’ main characteristics both during the national banking era and the Federal Reserve System.
Characteristics of Panics of the National Banking Era
During the National Banking era (1863-1913) episodes of banking panics were accompanied by money market stringency, a stock market collapse, loan and deposit contractions, runs on banks, bank failures, the issue of Clearing House certificates, and in the case of the three major banking panics the partial suspension of cash payment. The general public had little or no direct experience of bank runs and bank suspensions, for their numbers were small with one exception and were highly concentrated. The partial suspension of cash payment was more widely diffused and brought home to the many the realization of a banking panic. The proximate effects of partial suspension of cash payment included: 1) difficulties encountered by business firms in meeting payrolls, 2) dislocation of the domestic exchanges, 3) an increase in hoarding, and 4) the emergence of a currency premium. This disruption of the payments mechanism led to an increase in real transactions costs, temporary factory closings, layoffs, and the creation of currency substitutes. The domestic exchanges were disrupted because bankers were reluctant to make remittances. Failure to remit on time encouraged firms to demand cash payment, thereby reducing real transactions.
Characteristics of Panics of the Great Depression
The banking panics of the Great Depression differed from the pre-1914 panics in the following ways:
1. Unlike pre-1914 panics, there were multiple banking crises during the contraction phase of a single cycle from 1929-1933, at least two of which were region specific.
2. The “eye” of the crisis was no longer in the New York money market.
3. At least two of the insidious effects of the pre-1914 crises had been eliminated, spikes in the call money rates and serious stock market upheavals. The 1929 stock market collapse was not accompanied by a banking panic due to the quick action of the Federal Reserve Bank of New York.
4. Unlike pre-1914 banking panics, there was greater elasticity of the currency supply in response to the increased demands of the public. Federal Reserve notes expanded substantially in each of the four banking panics.
5. Except for 1933, banks did not suspend cash payment.
The significant fact about the Great Depression banking panics is the occurrence of multiple panics; there was a continuous deterioration of depositor confidence as revealed by the monthly data on currency in circulation seasonally adjusted. In neither 1930 nor 1931 did the ending of the banking crisis result in a return flow of currency. Deceleration of bank suspensions was not followed by dishoarding as in previous panics. During 1930 and 1931 banking panics, hoarding accelerated during the panic, leveled off at a higher plateau, and then resumed an upward thrust at the onset of the next shock to depositor confidence.
The Federal Reserve eliminated crises in the central money market by increasing the availability of reserves.
One of the principal characteristics of banking panics is the increased number of bank runs and bank suspensions. The evidence does not permit an estimate of the number of all bank runs. Table 1 provides estimates of bank suspensions in each of the five banking disturbances of the national banking era and three of the four banking panics of the Great Depression. Estimates for 1933 are not included because of widespread bank holidays in the last week of February and March.
Number of Bank Failures: National Banking Era and Great Depression
|National Banking Era||Great Depression|
|Panic Dates||Number of Failures||Panic Dates||Number of Failures|
|September 1873||101||November-December 1930||806|
|May 1884||42||April-August 1931||573|
|November 1890||18||September-October 1931||827|
|May-August 1893||503||June-July 1932||283|
|October-December 1907||73||February-March 1933||bank holiday|
Source: Wicker (2000), p. 143.
We cannot but be surprised at the smallness of the number of bank suspensions before 1914, the exception being 1893. The banking disturbances of 1884 and 1890 hardly qualify as banking panics, and I have excluded them. I prefer to label them incipient panics because they were forestalled by effective action of the NYCH.
Suspensions of the Great Depression
During the banking panics of 1930 and 1931 there was no uniform response across the twelve Federal Reserve Districts, whether measured by the bank suspension evidence or the loss of depositor confidence as reflected in Federal Reserve notes in circulation. These three (one in 1930 and two in 1931) banking panics were region specific inasmuch as at least one-half of the Districts had either fewer than 10 percent of the bank closings (1930) or there was little or no change in hoarding (April-August 1931).
Two out of every five closings during the 1930 panic were located in the St. Louis Federal Reserve District. Four Districts accounted for 80 percent of total bank suspensions, and slightly over one-half of the deposits of failed banks. Between April and August 1931, one-third of the bank suspensions were in the Chicago District. There was a mini panic in Chicago in June and a full-scale panic in Toledo in August. The Cleveland Federal Reserve District had two-thirds of the deposits of suspended banks. However, in six Districts there was little or no change in currency hoarding.
During the September-October crisis in 1931 three Districts, Chicago, Cleveland and Philadelphia accounted for two-thirds of the deposits of suspended banks and one-half of the increase in hoarding. Moreover, there was a high concentration of suspensions in three cities: Pittsburgh, Philadelphia, and Chicago.
Suspensions in the National Banking Era
The highest concentration of bank failures in 1873 was in three states: New York, Pennsylvania and Virginia with over 70 percent of all suspensions. There were serious city-wide bank runs in Augusta and Savannah, Georgia, Louisville, Charleston, South Carolina, Nashville and Knoxville, Tennessee and Petersburg and Richmond, Virginia. Unprecedented runs on banks occurred in June and July 1893. The distinctive characteristic of the July suspensions were city-wide panics in Kansas City, Kansas and Kansas City, Missouri, Denver, Louisville, Milwaukee, and Portland, Oregon. The closures in Kansas City, Denver, and Louisville accounted for one in four suspensions in the western states but nearly 70 percent of the liabilities of closed banks. The key to understanding what happened in July is what happened in these six cities.
The most surprising conclusion to emerge from the narrative of what happened in these six cities during July is the proportion of banks that suspended and resumed operations within three months. These banks appear to have been solvent at the time of closure. It is indeed striking that over 90 percent of the banks in Kansas City, Portland, Oregon and sixty-five percent in Louisville and Denver were solvent a the time of the bank runs!
The banking panic of 1907 was the most severe of the panics of the national banking era if measured solely by deposits of failed banks. Bank runs were long and persistent for some trust companies, but the overall number of suspensions remained small. Severity of Bank Suspensions
Table 2 attempts to measure the relative severity of bank suspensions during the two periods by showing the ratio of total bank suspensions to the total number of banks in existence at the beginning of each panic, 1873 and 1933 excepted.
Total Bank Suspensions as a Percent of Total Number of Banks in Each of the Banking Crises, 1873- 1931
|National Banking Era||Great Depression|
|Panic Date||Percentage||Panic Date||Percentage|
Note: The number of state and national bank suspensions as a percentage of the total number state and national banks was 1.648% in 1873. I have not uncovered estimates of the total number of unincorporated banks for 1873. Source: Wicker (2000), p. 6.
There are no estimates of the total number of banks in 1873 and the estimates for 1933 are inflated by bank closings resulting from banking holidays. It is quite clear that bank suspensions in the national banking era were less severe, except for the banking panic of 1893. In 1884, 1890 and 1907, less than one percent of banks were suspended, whereas in the most severe panics the suspension rates were between 2.95% and 4.27%.
The NYCH and Panics during the National Banking Era
Structural weaknesses of the National Banking Act have been widely perceived as the fundamental cause of the panics of the national banking era. An inelastic currency supply, the pyramiding of reserves and fixed reserve requirements have borne a large share of the blame to the almost complete neglect of the behavior of the New York Clearing House. The NYCH had the power, the knowledge (at least initially) and the instruments to forestall banking panics. Both the size and distribution of the banking reserve among the NYCH banks was conducive to the recognition of the specific role played by the New York banks in the maintenance of banking stability. The ultimate banking reserve of the country was lodged in six or seven of the largest New York banks. The size of that reserve was greater than that held by any of Europe’s central banks. Learning how to use that reserve was the chief task of the NYCH during the national banking era. The Clearing House had two principal instruments for managing the reserve: the issue of clearing house certificates and reserve pooling. The NYCH had the authority whenever it deemed it necessary to equalize or pool the reserves of the NYCH banks by transferring funds of surplus banks to deficit banks. The significance of reserve pooling was clearly understood by a special committee headed by George S. Coe, President of the Exchange National Bank. The Committee issued a report in November 1873 that effectively made the case that banking panics could be averted if the NYCH exercised bold leadership and was fully prepared to use its power to achieve its objective, which, it did effectively in 1860 and 1861 and again in 1873 with less success. Thereafter that knowledge seems to have faded from the collective memory of the Clearing House.
Causes of Depression-era Panics
Structural weaknesses may have been less important in generating the banking panics of the national banking era than the behavior of the NYCH, but they did play a prominent role in generating the panics of the Great Depression. The creation of the Federal Reserve was supposed to have been a panacea for the prevention of banking panics, yet the worst banking panics in our banking history occurred thereafter. How was that possible? Did the fault lie in the legislation creating the Fed or was Fed leadership culpable? Friedman and Schwartz (1963) attempted to unlock this riddle in terms of personalities, but there is a compelling alternative, which they rejected, that deserves reconsideration. Structural weaknesses in the original Federal Reserve Act can explain equally well, if not better, why the Fed failed to prevent the panics of the Great Depression. There were at least three important structural flaws in the 1913 Federal Reserve Act: l) membership was not compulsory for all banks; it was mandatory for national banks and optional for state banks and trust companies thereby restricting access to the discount window; 2) paper eligible for discount by member banks was too narrowly defined; and 3) power was decentralized among the twelve Federal Reserve Banks and the Federal Reserve Board making consistent and effective policy action difficult. These combined structural weaknesses hindered policymakers’ efforts to respond quickly at the onset of banking panics. When four out of five bank suspensions during the three panics of 1930 and 1931 were nonmember banks, it is time to reconsider the membership question as a cause of the Great Depression panics.
Random Withdrawal Theory vs. Asymmetric Information Theory
Calomiris and Gorton (1991) have identified for purely expository purposes two rival theories of banking panics around which research has “coalesced.” One theory descends directly from the seminal work of Diamond and Dybvig (1983) and has been labeled the random withdrawal hypothesis. The other has a varied origin associated with, among others, Gorton (1987) and Jacklin and Bhattacharya (1988) and is referred to as the asymmetric information approach. The random withdrawal hypothesis attributes bank suspensions to bank illiquidity induced by a contagion of fear. The asymmetric information approach assigns a key role to bank insolvency induced by asset shocks due to weak management, fraud and malfeasance, or persistent adverse economic conditions in a particular sector. This classification does not preclude that both may be at work simultaneously
The historical evidence is ambiguous about the validity of the two hypotheses. Asset shocks were clearly dominant in some panics, for example 1873 and 1884. Contagion played a far more important role during 1893 and 1933. Saunders and Wilson (1993) found significant contagion effects for a sample of national bank failures for the period 1930-32. Generalization is simply not possible. Each panic must be considered on its own merits.
The banking panic of 1930 has had special significance among the panics of the Great Depression because of the causal role assigned to it by Friedman and Schwartz. They maintained that an autonomous disturbance in the currency-deposit ratio provoked a rash of bank suspensions that decreased the money stock, which, in turn, converted a mild recession into a major depression. To have exerted a causal role, panic-induced bank suspensions must have been exogenous, that is, independent of price changes, interest rates and income. Boughton and Wicker (1979 and 1984) demonstrated that interest rates and income were important determinants of the money stock. The finding that the currency-deposit ratio was interest sensitive was consistent with Temin’s (1976) view that causation went from income and interest rates to money, not vice versa. The evidence on the causal role of money remains controversial; the historical evidence has still to be reconciled with the econometric evidence.
Disappearance of Panics after 1933
The long era of banking disturbances finally ended in 1933 due partly to the introduction of deposit insurance, improved performance of the Federal Reserve, and a better understanding of the sources of systemic banking unrest. Knowledge alone, we have learned, is not a sufficient guarantee to forestall banking panics. Leadership and policymaker competence are important as well.
Boughton, James and Elmus Wicker. “The Behavior of the Currency-Deposit Ratio during the Great Depression.” Journal of Money, Credit, and Banking 11 (1979): 405-18.
Boughton, James and Elmus Wicker. “A Reply to Trescott.” Journal of Money, Credit, and Banking 16 (1984): 336-7.
Calomiris, Charles W. and Gary Gorton. “The Origins of Banking Panics: Models, Facts, and Bank Regulation.” In Financial Markets and Financial Crises, edited by R. Glenn Hubbard, 109-173. Chicago: University of Chicago Press, 1991.
Diamond, Douglas and Philip Dybvig. “Bank Runs, Liquidity, and Deposit Insurance.” Journal of Political Economy 91, no. 3 (1983): 401-19.
Friedman, Milton and Anna Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.
Gorton, Gary. “Bank Suspensions and Convertibility.” Journal of Political Economy 15 (1987): 177-93??
Jacklin, Charles J. and Sudipto Bhattacharya. “Distinguishing Panics and Information-based Bank Runs: Welfare and Policy Implications.” Journal of Political Economy 96, no. 3 (1988): 568-592.
Saunders, Anthony and Berry Wilson. “Contagious Bank Runs: Evidence from the 1929-1933 Period.” Journal of Financial Intermediation_ 5, no 4 (1996): 409-23
Temin, Peter. Did Monetary Forces Cause the Great Depression? New York: W.W. Norton, 1976.
Wicker, Elmus. The Banking Panics of the Great Depression. New York: Cambridge University Press, 1996.
Wicker, Elmus. Banking Panics of the Gilded Age. New York: Cambridge University Press, 2000.
Citation: Wicker, Elmus. “Banking Panics in the US: 1873-1933”. EH.Net Encyclopedia, edited by Robert Whaples. September 4, 2001. URL http://eh.net/encyclopedia/banking-panics-in-the-us-1873-1933/