Banking Crisis of 1933

A nationwide panic ensued in 1933 when bank customers descended upon banks to withdraw their assets, only to be turned away because of a shortage of cash and credit. The United States was in the throes of the Great Depression (1929–41), a time when the economy worsened, businesses failed, and workers lost their jobs. Bank customers did not have the benefit of government protection during the panic. The crisis led to government reform to protect bank deposits.

President Hoover and the Great Depression

The Great Depression began in October 1929, when the value of stocks traded on the stock market in New York fell tremendously. In only a few weeks, investors lost a sum of money that approached the national cost of fighting World War I (1914–18). At the time, banks opened as they always had, five weekdays plus Saturday mornings. Despite the severity of the stock market crash, within months political leaders announced brightly that the country was recovering and business was healthy. Financial panics in the past had usually come and gone quickly after speculators absorbed their losses. This time, however, the economy did not recover quickly.

In 1932, President Herbert Hoover (1874–1964; served 1929–33) took steps to improve the economy. He created the Reconstruction Finance Corporation, a government project for lending billions of dollars to various enterprises, including banks. The injection of money did not help enough. Shantytowns of tin and wood spread across the country and became known as Hoovervilles . Homeless people on park benches tried to keep warm with newspapers, known as Hoover blankets.

Bank runs

When depositors rushed to withdraw their money from a bank, the incident was called a bank run. Bank runs were spurred by fears that banks would go bankrupt, taking the savings of depositors with them. The mere hint of a bank closing often was enough to send depositors scrambling to withdraw their money. This resulted in banks, which do not keep enough cash on hand to cover all of their deposits, often collapsing.

Bank runs had serious effects because of unsound banking practices. During the 1920s, many banks had not acted in a responsible fashion. Some had lent money for poor investments. Others extended dangerously large credit to financial speculators. When the stock market crashed, many banks saw their assets evaporate. Creditors who had lent money to the banks liquidated what remained, and individual depositors were left with nothing.

Because few companies in the 1920s provided pensions for workers, many used the banks as a place to deposit a lifetime's worth of savings in anticipation of retirement. When the banks went under, many of these people, old and unable to work, lost everything. More than fourteen hundred banks collapsed in 1932, taking with them $725 million in deposits. The public scrutinized the remaining banks. At the first sign of trouble, a run on the banks occurred, and the banks usually ended up closing, many permanently.

Bank holidays

By March 1933, before President Franklin D. Roosevelt (1882–1945; served 1933–45) took office, about nine million people had lost their savings. It was clear that some action was necessary. State after state declared banking “holidays” that month, briefly closing local banks to prevent nervous depositors from creating bank failures with bank runs.

The day after his inauguration, President Roosevelt called Congress into a special session and announced a four-day nationwide banking holiday. While the banks were closed, the president introduced the Emergency Banking Act of 1933, which Congress passed the same day. During this bank closure, many people ran short of cash. In an era before credit cards, people without hard currency were unable to purchase groceries or attend public events.

These short-term and relatively minor hardships were offset by the fact that the federal banking holiday worked. In his first radio “fireside chat,” broadcast three days after the banks were closed, President Roosevelt reassured the public that the banks had been made safe. The president's personal charm and his fondness for decisive action were apparent in this first New Deal success. The New Deal was a series of legislative and administrative programs initiated by President Roosevelt as a way to combat the effects of the Great Depression. Within the month, banking deposits had grown by more than a billion dollars.

The Pecora investigation

While the Roosevelt administration was busy restoring public confidence in banks, Congress was punishing bankers for old violations of the public trust. In 1933 and 1934, sensational hearings were held that detailed theft and fraud on the part of many bankers and other members of the business community. This introduced the term “bankster” to the cultural vocabulary.

The Senate Banking and Currency Committee, led by appointed New York legal counsel Ferdinand Pecora (1882–1971), revealed that the brokerage house of Lee, Higginson, and Company had defrauded the public of $100 million. National City Bank head Charles E. Mitchell (1877–1955), with a salary of $1.2 million, paid no income tax and had issued $25 million in Peruvian bonds that he knew to be worthless. Former secretary of the treasury Andrew Mellon (1855–1937) and banker J. P. Morgan (1837–1913) had also managed to avoid taxes, and twenty of Morgan's partners had paid no taxes in 1931 and 1932.

Throughout the hearings, the public was introduced to such Wall Street tactics as selling short, pooling agreements, influence peddling, insider trading, and the wash sale. By using such techniques, traders artificially inflated the worth of their stocks or gained financial advantage over other traders. National City Bank, for example, took bad loans, repack-aged them as bonds, and sold them to unwary investors. Although such actions were technically legal, many viewed them as unethical and immoral, and the public reputation of bankers and financial businesspeople fell to a new low.

Banking regulation: the FDIC

The first reform to result from the Pecora investigation was the Glass-Steagall Act of 1933. It was a law sponsored by U.S. senator Carter Glass (1858–1946) of Virginia and U.S. representative Henry Steagall (1873–1943) of Alabama amid a rash of bank failures. The law regulated many of the unsound practices that contributed to the Great Depression, including making it illegal for banks to deal in stocks and bonds.

The act created the Federal Deposit Insurance Corporation (FDIC) to insure small depositors against the loss of their savings if a bank went under. The FDIC initially guaranteed deposits to a maximum of $5,000.