by Prins, Nomi
The man who had the most on the line was characteristically enthusiastic about the economic fallout. “The recession will not last long,” proclaimed National City Bank head Charles Mitchell on January 15, 1930.1 If one simply considered the invigorated behavior of the stock market, that conclusion was almost believable. For it was enjoying a brief resurgence from its Black Tuesday depths. Dipping to a low of 199 on November 13, 1929, the market was on its way up to 294, a 50 percent increase, by April 17, 1930.2 Bankers, politicians, and a Wall Street–infatuated media gushed optimism at every point along the way. After a few threatening comments by some senators right after the Crash, there didn’t seem to be much lingering concern about investigating how the financial system could bounce up and down so quickly—or who was responsible. The rebound was all that mattered.
But those delusional days were short-lived. The economy had suffered a severe blow not just because of the Crash but because of the preceding years of excess and borrowing to support that excess, yet its weakness was masked by the vibrant stock market. Bankers had been fortified by the Fed to “try again,” but the injection of post-Crash speculative money in the market simply couldn’t negate systemic problems for very long. There were too many bonds defaulting, too many businesses closing, and too many people losing their jobs and their hope of a more secure future. The money that was being funneled into the market to fuel financial speculation (rather than productive or social capitalism) provided the illusion of stability and prosperity, but it was not the kind of long-term capital upon which true economic growth could be sustained. Paper profits had shriveled faster than they had once increased. This could, and would, happen again.
Yet President Hoover, either because he wasn’t fully informed about the inner workings of the markets by his banker friends or because he didn’t want to admit that the bottom could still fall out of the economy on his watch, found himself pulling a Mitchell. On May Day 1930, he declared to the nation, “We have now passed the worst and with continued unity of effort we shall rapidly recover.”3 His statement wound up foreshadowing a nearly two-year market dive to a low of 41 on July 8, 1932, and a Great Depression that brought the American economy to its knees.
Were it not for parallel crises unfolding globally, the Depression would have dampened America’s international power. But since the rest of the world would suffer in tandem, America would retain and even extend its dominant position throughout the 1930s. By the decade’s end, the Depression would become the backdrop for another world war, and a war effort that would unite most of the same banks as the first one.
The Fed-Bank Shuffle
The first wave of deepening Depression, in the fall of 1930, coincided with the first of three major episodes of bank closings and mini panics. It began in the Midwest, where banks had been starved for credit since the Crash. The Fed stayed out of the fray. In general, it showed little empathy for the general credit condition of the country, focusing instead on how the big banks were faring. The Fed governors were pleased that the level of indebtedness at the bigger member banks hadn’t changed much since the Crash, a sign they deemed as a positive indicator of a recovery.
But the population wasn’t experiencing a recovery at all, especially not in the poorest areas. As the Fed reported, “The growth of deposits . . . has not been felt by rural communities. . . . At the present time their level is lower than at any time in recent years.”4
It wasn’t surprising that there was no growth in deposits; the public couldn’t manufacture money out of thin air. Yet the Fed board remained blissfully unaware of the broader hardship and focused instead on its elite members. Thus it concluded in October 1930, “The exceptionally strong position of commercial banks and of the reserve banks, the prevailing ease in credit conditions, the low level of money rates, and the attitude of the federal reserve system” meant “the country’s credit resources will be available to facilitate in every possible way the orderly movement of agricultural commodities from the producer through the channels of trade to the ultimate consumer.”5 (The Fed’s obliviousness about broad economic malaise would resurface after the 2008 crisis.)
It didn’t work out that way. By the end of 1930, it was clear that a new group on Wall Street, comprising most of the same banks as in the early 1900s but with new faces at their helms, was selecting which companies would live or die based on the relationships of their leaders to the likes of the Morgan Bank, National City Bank, and Chase. As such, the New York–based Bank of United States collapsed on December 11, 1930, eviscerating $200 million in deposits and wiping out the accounts of about four hundred thousand people (or two hundred thousand families).6
The Bank of United States was the largest bank in New York and the first major financial firm to close, and it had catered mostly to ordinary citizens. The average account there contained about $200, some families’ total savings. The impact of the closing was that much sharper for the mostly Jewish and immigrant customers.
The bank wasn’t innocent in its downfall. It had employed a plethora of shady schemes before its demise, such as selling shares of its stock to depositors at $200 a pop, assuring them they could sell the stock at the same price at any time (which turned out not to be the case). By early December shares were trading at 20 percent of their original value. And that was just the beginning.
The Big Three, a subset of the Big Six that included Thomas Lamont, Albert Wiggin, and Charles Mitchell, convened to consider bailing out the Bank of United States. But as Liaquat Ahamed chronicled, “after an all-night meeting that spilled into the next day, not even pleas from New York superintendent of banks Joseph Broderick could convince these major players to save this bank.”7
Instead, the trio pushed the matter onto the New York State Banking Department, which took over the Bank of United States and concocted a plan with the Clearing House Association of banks whereby the bank’s customers could borrow up to half of their deposit values from a fund created by the Clearing House and the New York State Banking Department. No promises were made about returning the deposits.
Lamont was quick to distance the good banks (such as his) from the “bad” ones. At a meeting of the members of the New York Stock Exchange, he said that the problems leading to the closing of the Bank of United States were “not symptomatic” of the general New York banking community, which he characterized as being “founded on a rock.”8
The Bank of United States became the poster child for a bank that collapsed because of its “ill” practices; it was the Enron of its time. The philosophical cordoning off of such an errant bank shielded the big bankers from certain elements of investigation, as would later be shown during congressional hearings. They may have conducted similar activities, but they would not suffer the same consequences.
The Bank for International Settlements Is Born
President Hoover had reintroduced the term “Depression” in late 1929 to replace the more commonly used “Panic.”9 He thought it was more placating. The term stuck. Now, with domestic conditions faltering and people extracting their deposits, bankers turned to international markets to seek business and increase global influence.
Though the US economy was staggering, conditions were worse in Europe. Neither the Treaty of Versailles nor the Dawes plan had solved the war debt or German reparations problems, so US bankers needed another plan to keep the financial system percolating.
The first entity to be designed for that purpose, with a global name but a decidedly American bent, was the Bank for International Settlements—or, as it was fondly called among international bankers, the “cash register of German reparations.”
The BIS was officially established in Basel, Switzerland, on May 17, 1930. It would continue the ideas of the failed Dawes plan, which had been extended into the Young plan (fashioned by Owen Young). The charter for the BIS was adopted at a conference in The Hague on January 20, 1930; the BIS would deal with ongoing German reparations matters in conjunction with the bankers. It would ac
t as the new central body for the collection and distribution of payments, and as a trustee for the Dawes and Young loans that helped finance those reparations. The Young plan reduced German reparations payments further than the Dawes plan did and likewise allowed for the financing of those payments to come from private banks. It was another game of shuffle, but it allowed the American bankers to once again extend loans.
The seed money for the BIS (five hundred million Swiss francs) came from the same collection of banks that supplied loans to Europe: J. P. Morgan & Company, along with several central banks.10 That money would be fused with capital from the New York Fed, despite the lack of a mandate or precedent for such an action—other than the fact that its former chairman, Gates McGarrah, was appointed as the first head of the BIS.
Six months into McGarrah’s appointment, he and Chase chairman Al Wiggin were working hard to turn the global Depression into something financially and politically expedient for the United States and its financiers. The international focus provided both men a shield of sorts—it protected McGarrah from culpability in his banker-friendly role at the helm of the New York Fed during the lead-up to the Crash and diverted attention from the fraud Wiggin had committed against his own bank, which no one knew about yet.
The Wiggin Committee
On a frigid afternoon in January 1931, Wiggin issued a report to his shareholders. He blamed Europe’s precarious debt position, rather than banks’ speculative and credit-overextension actions, for the dire economic situation. (This was not too different from the blame placed on ransacked European countries following the US crisis in 2008.) His solution was not too different from the one Lamont had proposed during the mid-1920s: to effectively make it easier for Europe to borrow from US banks by reducing their current debt.
As he said, “Cancellation or reduction of the international debts has been increasingly discussed throughout the world. . . . I am firmly convinced it would be good business to initiate a reduction of these debts at this time.”11
This was code for wanting to keep the bank’s biggest borrowers coming back for more. President Hoover would have to find a way to do as Wiggin was suggesting while balancing the move with the political ramifications of helping Europe financially at a time when the public was primarily concerned with its own economic survival (even more so than it had been during the recent isolationist wave).
A few years earlier, President Coolidge had selected a fairly passive Federal Reserve head in Roy Young. Neither man believed that the Fed should have undue influence over economic policy. In 1928, Coolidge had stated that stock market speculation should not cause alarm, which dovetailed with Young’s policies of leaving the banks alone. Under Young the Fed had not interfered with banks borrowing at the discount window at rates near 6 percent and lending those funds at rates near 12 percent in 1929, providing lots of incentive for them to make speculative loans.
The New York Fed had acted on Charles Mitchell’s wishes.12 He had pushed harder than anyone for rates to remain low and borrowing to remain cheap before the Crash. Indeed, when the New York Fed’s board of directors voted to increase rates between February and May 1929, Mitchell objected.13
McGarrah supported Mitchell, and on May 31 he upped the ante. He told the Federal Reserve Board that “it may soon be necessary to establish a less restricted discount policy in order that the member banks may more freely borrow for the proper conduct of their business.” The board kept the discount rate at 5 percent.
A week later, emboldened by the support, Mitchell urged a more liberal discount policy and an easing of credit conditions through a Fed purchase of bills and government securities. (The Fed did the same thing after the 2008 crisis.) Mitchell knew well the first law of banking—cheap money is better than expensive money—and used that mantra to force the Fed to keep him afloat for as long as possible.
With McGarrah at the BIS, it was Roy Young (who had left his post as Fed chairman on August 31, 1930) who came under fire setting those terms. According to the Senate Banking and Currency Committee subcommittee hearings held in January and February 1931, it was Young, not the bankers, who had been ineffectual in thwarting the speculation that led to the Crash.
Instead of raising the discount rate sooner, the consensus was that Young merely issued verbal warnings to the public to curb speculation in the late 1920s. Arguably, warning the public rather than clamping down on banks was wrong for more reasons than the committee discussed. The public wasn’t responsible for shady trusts, speculative stock pools, or bank-engineered fraud. But blame doesn’t need to be logical if it serves the political purpose of alleviating culpability for those levying it.
During the hearings, according to Time, witnesses placed fault largely with Young’s “foggy-headed uncertainties.”14 That was rather unfair, though. Domestic and international speculation had been brewing for half a decade, pooled trusts had been sprouting for years, and tremendous fraud had been perpetrated to manipulate prices, as was later presented at the Pecora hearings. Quibbling about a six-month period of hiking rates seemed ridiculous then, and seems even more so with the benefit of hindsight. But nonetheless it proved politically useful at the time by shielding the president and the bankers.
A few months later, in the summer of 1931, Wiggin took a team of Chase bankers with him to Europe.15 On a balmy August afternoon, Wiggin played master of ceremonies to representatives from twelve countries who had gathered in a swanky hotel room in Basel. Reporters referred to them as the Wiggin Committee.16
The point of the meetings was to investigate Germany’s ongoing credit problems. In 1930 Germany owed more than twenty-five billion reichsmarks to foreign lenders (about $65 billion after adjusting for inflation), predominantly as a result of World War I reparations.17 Yet with unemployment above 33 percent and facing a massive collapse in industrial production, Germany was having trouble making payments. The crisis was made worse by a divided government challenged by growing political extremism inside and outside the Reichstag.18 Just three months before the Wiggin Committee met, the Austrian lender Credit-Anstalt—the biggest bank east of Germany—had gone bankrupt, unleashing a knock-on effect on German banks and leaving the German economy teetering on the precipice of disaster.19
The Wiggin Committee pressed for a six-month debt moratorium for Germany’s foreign creditors. Wiggin cared deeply about the issue; Chase had issued more short-term debt to Germany than any other US bank, and since the Crash it had been unable to collect the money it was owed.20 Wiggin was less concerned about the long-term loans his bank and others had sold to the public, but he cared a lot about those short-term notes because his bank had lent its own cash against them. (Chase eventually got paid after Wiggin and John Foster Dulles sailed to Europe in May 1933 to meet with German authorities.21 But all $1.2 billion of the public-financed long-term loans went bust.22)
In Basel, Wiggin not only represented Chase but all New York banks. He had taken a group of Chase men with him, though the international community had expected Jack Morgan or Tom Lamont to lead such a gathering, as had been the custom since the World War I days.23 But that might have been awkward. First, Chase was one of the largest US holders of German bonds.24 Second, Morgan had served primarily as France’s banker.25 It would have been odd for a Morgan partner to oppose France’s wishes regarding Germany in such an open forum, and France was against any sort of help for Germany’s debt problems; it had enough economic concerns of its own.
Wiggin was happy to play the power broker role that J. P. Morgan had played when the two men first crossed paths during the 1907 panic, only now in a more international realm. His famous rejection of a Morgan partnership back then had stemmed from his desire to make his own mark in the world. This was his opportunity.
Germany had already appealed to President Hoover for a debt moratorium. Unlike the isolationist mid-1920s when such an official stance would have been unthinkable, this time the world economy, including the United States, was in danger. On June 20, 19
31, Hoover had proposed a one-year moratorium on “all payments on intergovernmental debts, reparations, and relief debts.”26 Debts to private banks were excluded from his proposal.
Hoover explained to the American public, “The worldwide depression has affected the countries of Europe more severely than our own.” He said this situation could hurt the United States: “The fabric of intergovernmental debts, supportable in normal times, weighs heavily in the midst of this depression.”27 The proposed moratorium was not about taking sides regarding European countries or internationalism per se; it was a matter of global and American economic stability.
Finally, on July 6, France had agreed to Hoover’s moratorium, raising the number of nations supporting it to fifteen. But it was too late. The damage to Germany’s economy, which would lead to a seismic economic breakdown and sow the seeds of the next world war, had been done. By the time the National Socialist government consolidated its power in 1933, German payments had stopped; only about one-eighth of the original amount from the Treaty of Versailles was paid. Contributing heavily to Germany’s economic problems and the rise of the Third Reich were the additional piles of loans extended by the private banks to “help” Germany abide with the Treaty of Versailles, Dawes plan, and Young plan stipulations. Those private loans didn’t get repaid either.
The Great Depression’s Global Reach
The banking system failures throughout Austria and Germany, and the Wiggin and Hoover moratoriums, were followed by Britain’s abandoning the gold standard on September 21, 1931. The global Depression was in full swing.
In the United States, hundreds of other banks were closing their doors. City landlords were throwing out more and more tenants for not making rent. Home foreclosures spiked. People couldn’t afford heating fuel during the harsh winter months. Construction and other jobs disappeared. Smaller businesses weren’t making enough money to pay operating costs, let alone the interest on their loans. They didn’t get debt moratoriums; they just defaulted. Meanwhile, banks were steeped in self-preservation mode. By mid-1931, mass layoffs were the ugly norm. Even Henry Ford shut down many of his car factories in Detroit, throwing seventy-five thousand men out of work.28
