With the Depression and the ensuing stagnation in trade, prime bills were scarce and hard to find. The Fed had to rely on gold to back its currency. Thus, in the fall of 1931, instead of having $2 billion too much gold and being grateful that some of it was finally flowing back to Europe, it found itself scrambling to hold on to its reserves. It was a manufactured problem, the result of an anachronistic regulation that had no basis in economic reality but which tied up a large amount of U.S. gold unnecessarily.
And so early that October, in the midst of the Depression, as bank runs raged across the Midwest, thousands of businesses closed down, and industrial production contracted at an annualized rate of 25 percent, the Fed raised interest rates from 1.5 percent to 3.5 percent. With prices falling by 7 percent a year, this put the effective cost of money above 10 percent. So dominant was the view that abiding by these reserve requirements trumped every other consideration, there was no internal resistance at the Fed to jacking up the cost of credit. Even the two principal expansionists, Meyer and Harrison, went along.
The president still continued to cling to the notion that private sector initiatives were the best way to revive the economy. On the evening of Sunday, October 4, he secretly slipped out of the White House and made his way to Mellon’s apartment at 1785 Massachusetts Avenue, where Harrison of the New York Fed had assembled a group of nineteen New York bankers, among them Thomas Lamont and George Whitney of J. P. Morgan & Co., Albert Wiggin of Chase National, William Potter of Guaranty Trust, and Charlie Mitchell of National City—in short, the usual suspects. Amid the Rubens and Rembrandts, which Mellon had so assiduously collected, the president outlined a plan to try to break the vicious cycle whereby people were pulling cash out of banks and banks were having to cut credit.
Banks were going under in part because the assets they held on their books could not be used as collateral to borrow from the Fed. By the fall of 1931, the neat distinction between liquidity and solvency on which the Fed, following Bagehot, had placed so much emphasis, was becoming meaningless. Many banks experiencing withdrawals would have been fine under normal circumstance, but forced to call in loans and liquidate assets in a falling market at fire-sale prices, they were being driven into insolvency. Hoover proposed that a new fund of $500 million be created by the larger and stronger private banks to lend to smaller banks on collateral that the Federal Reserve was legally unable to accept.
That meeting went on long into the evening. The bankers were dubious about the idea and kept asking why the government or the Fed did not act—had not the Fed after all been created precisely to avoid such banking panics? Hoover returned to the White House after midnight “more depressed than ever before.” The next day, prodded by Harrison, the bankers reluctantly agreed to try the plan. Over the next few weeks, the new fund lent a grand total of $100 million and then, paralyzed by its proprietors’ ultraconservatism and fear of losing money, folded. The days of the great Pierpont Morgan, when large banks assumed responsibility for propping up smaller ones and for supporting the integrity of the entire financial system, were long gone.
The bank runs, the spike in currency hoarding, and now the rising cost of money imposed a massive and sudden credit crunch upon an already fragile United States. Between September 1931 and June 1932 the total amount of bank credit in the country shrank by 20 percent, from $43 billion to $36 billion. As loans were called in, small businesses were driven into default. Lenders were forced to absorb losses and in turn lost their own cushion of capital, making depositors quite justly fearful for the security of their money and leading to further withdrawals from banks, which in turn forced more loan recalls and thus more defaults. Though depositors and bankers individually behaved quite rationally to protect themselves, collectively their actions imposed a vicious spiral of tightening credit and loan losses on the already depressed U.S. economy.
“If there is one moment in the 1930s that haunts economic historians,” writes the economist J. Bradford DeLong, “it is the spring and summer of 1931—for that is when the severe depression in Europe and North America that had started in the summer of 1929 in the United States, and in the fall of 1928 in Germany, turned into the Great Depression.” The currency and banking convulsions of 1931 changed the nature of the economic collapse. As prices fell and businesses were unable to service their debts, bankruptcies proliferated, further chilling spending and economic activity. A corrosive deflationary psychology set in. Fearing that prices would fall further, consumers and businesses cut spending, adding to the downward spiral in consumption and investment.
Every economic indicator seemed to fall off a cliff—1932 was the deepest year of depression in the United States. Between September 1931 and June 1932, production fell 25 percent; investment dived a stunning 50 percent; and prices dropped another 10 percent, reaching 75 percent of their 1929 level. Unemployment shot up beyond ten million—more than 20 percent of the workforce was now without jobs.
American corporations, which had made almost $10 billion in profits in 1929, collectively lost $3 billion in 1932. On July 8, 1932, the Dow, which had stood at 381 on September, 3, 1929, and was trading around 150 before the European currency crisis, hit a low of 41, a drop of almost 90 percent over the two and a half years since the bubble first broke. General Motors, which had traded at $72 a share in September 1929, was now a little above $7. And RCA, which had peaked at $101 in 1929, hit a low of $2. When, in August 1932, a reporter for the Saturday Evening Post asked John Maynard Keynes if there had ever been anything like this before, he replied, “Yes. It was called the Dark Ages, and it lasted four hundred years.”
In 1932, Meyer, having uncharacteristically allowed himself to be hamstrung by the Fed bureaucracy for his first year in office, finally took charge. In January, he persuaded the administration that its attempt to have the large banks voluntarily take responsibility for supporting the system had failed. The Reconstruction Finance Corporation (RFC) was established to channel public money—a total of $1.5 billion—into the banking system. Congress would agree to the new agency only if Meyer took on the chairmanship. For six months Meyer held two full-time posts: head of the RFC and chairman of the Federal Reserve Board. Eventually the toll on him became so great that his wife, Agnes, personally lobbied the president for him to resign one of the positions.
In February 1932, he pressed Congress to pass legislation that would make government securities an eligible asset to back currency. At the stroke of a pen the gold shortage was lifted, allowing the Fed to embark on a massive program of open market operations, injecting a total of $1 billion of cash into banks. The two new measures combined—the infusion of additional capital into the banking system and the injection of reserves—allowed the Fed finally to pump money into the system on the scale required. But Meyer had left it too late. A similar measure in late 1930 or in 1931 might have changed the course of history. In 1932 it was like pushing on a string. Banks, shaken by the previous two years, instead of lending out the money used the capital so injected to build up their own reserves. Total bank credit kept shrinking at a rate of 20 percent a year.
Bankers and financiers, the heroes of the previous decade, now became the whipping boys. No one provided a better target than Andrew Mellon. In January 1932, a freshman Democratic congressman from Texas, Wright Patman, opened impeachment hearings for high crimes and misdemeanors against the man once hailed as the “greatest Secretary of the Treasury since Alexander Hamilton.” Mellon found himself accused of corruption, of granting illegal tax refunds to companies in which he had an interest, of favoring his own banks and aluminum conglomerate in Treasury decisions, and of violating laws against trading with the Soviet Union. During the ensuing investigations, it turned out that he had used Treasury tax experts to help him find ways to reduce his personal tax bill and that he had made liberal use of fictitious gifts as a tax-dodging device. Being a member of the Federal Reserve Board, he had been required to divest his holdings of bank stock, with which he had duly complie
d—except that he had transferred the stock to his brother. In February, Hoover, recognizing that Mellon had now become a liability, packed him off as ambassador to London.50 His place was taken by his undersecretary, Ogden Mills.
On March 12, 1932, the world learned that Ivar Kreuger, the Swedish match king, who had bailed out so many penniless European countries, had shot himself in his apartment on the Avenue Victor Emmanuel III in Paris. At first it was assumed that he was just another victim of the times—he had recently suffered a nervous breakdown and his physician had warned him about the constant strain of his lifestyle on his heart. Within three weeks it became apparent that his whole enterprise had been a sham. His accounts were riddled with inflated valuations and bogus assets, including $142 million of forged Italian government bonds. When the losses to investors were eventually tallied, they amounted to $400 million.
Bankers were now increasingly viewed as crooks and rogues. In early 1932, the Senate Banking and Currency Committee began hearings on the causes of the 1929 crash. Designed at first to appease a public hungry for scapegoats, the hearings achieved little until, in March 1933, a young assistant district attorney from New York City, Ferdinand Pecora, took over as chief counsel. The public was soon riveted by the tales of financial skull-duggery in high places. It learned that Albert Wiggins, president of Chase, had sold the stock of his bank short at the height of the bubble and collected $4 million in profits when it collapsed during the crash; that Charles Mitchell, old “Sunshine Charlie,” of the National City Bank had lent $2.4 million to bank officers without any collateral to help them carry their stock after the crash, only 5 percent of which was repaid; that Mitchell himself, despite earning $1 million a year, had avoided all federal income tax by selling his bank stock to members of his family at a loss and then buying it back; that J. P. Morgan had not paid a cent of income taxes in the three years from 1929 to 1931.
“If you steal $25, you’re a thief. If you steal $250,000, you’re an embezzler. If you steal $2,500,000, you’re a financier,” wrote the magazine the Nation. Few critics went as far or tapped into as strong a vein of popular discontent as Father Charles Coughlin. Pastor of the Shrine of the Little Flower in Royal Oak, Michigan, Coughlin was the originator of right-wing radio. His Sunday afternoon broadcasts delivered in a soothing and intimate voice of mellow richness captivated millions as he held forth on the “banksters,” as he called them, who had led the country into the Depression.
He actually did have some understanding of the driving forces in international finance. For example, in a broadcast delivered on February 26, 1933, he explained somewhat cogently that “the so-called depression, with its bank failures, is traceable to the inordinate, impossible debts payable in gold—debts which came into being and were multiplied as a result of the war.” But he embellished his radio sermon with one of his fire-and-brimstone rants on “the filthy gold standard which from time immemorial has been the breeder of hate, the fashioner of swords, and the destroyer of mankind,” and ended by urging his listeners to rise up “against the Morgans, the Kuhn-Loebs, the Rothschilds, the Dillon-Reeds, the Federal Reserve banksters, the Mitchells and the rest of that undeserving group who without either the blood of patriotism or of Christianity flowing in their veins have shackled the lives of men and of nations with the ponderous links of their golden chain.”
The 1932 presidential campaign was dominated by the Depression. The Democratic candidate, Franklin Roosevelt, the handsome and attractive, astoundingly self-confident governor of New York, was initially dismissed as a lightweight. But his jaunty optimism—his campaign’s signature tune became “Happy Days Are Here Again”—his inspirational speeches, and his promise of vigorous action to restore prosperity made a sharp contrast with the dour and resentful Hoover.
On economics, Roosevelt had a breezy and disconcerting ability to put forward contradictory policies without the slightest embarassment. So while he pledged to increase federal relief for unemployment, supported higher tariffs, government development of power projects, increased regulation of securities markets, and the separation of commercial and investment banking, he also criticized Hoover for fiscal extravagance, accused him of encouraging inflation, and promised to balance the budget and commit himself to “sound money.” But voters did not care about consistency, they wanted bold action. In November 1932, Roosevelt got 22.8 million votes against Hoover’s 15.7 million, the greatest electoral sweep since Lincoln beat McClellan in 1864.
In the interregnum between the election and inauguration, a new wave of bank failures swept the country—this time starting in the West. On November 1, the governor of Nevada declared a twelve-day bank holiday, after the suspension of a bank chain that accounted for 65 percent of the state’s deposits. He was followed by his counterparts in Iowa in January 1933 and Louisiana in early February.
It was, however, the run on the Guardian Trust Company of Detroit, a bank controlled by Edsel Ford, scion of the Ford motor family, that transformed the new crisis into a national one. The Guardian Trust had done well during the 1920s financing consumer purchases of Ford cars. When auto sales dried up in the early 1930s, the bank found itself in serious trouble and had been forced to borrow from the RFC. In early 1933, the RFC balked at providing more money unless the sponsors, who were, after all, the second richest family in the country after the Rockefellers, put in more capital. Patriarch Henry Ford, now in his seventies and increasingly autocratic and unreasonable, refused to bail out his son. He had a long-standing antipathy to bankers and could not quite grasp why banks should be allowed to use the money he deposited for making risky loans—“It’s just as if I put my car in a garage and when I came to get it, I found somebody else had borrowed it and run it into a tree,” was the way he saw it. Faced with a statewide run on its banking system, on February 14, the governor of Michigan issued a proclamation closing all 550 banks in the state for eight days. The residents of Michigan woke up on Saint Valentine’s Day to find that all that they could draw upon was the cash in their pockets.
Across the country, depositors watching the whole monetary system of a major industrial state shut down began pulling their money out of their banks just in case. Governor after governor was forced to follow Michigan and declare a state bank holiday. Indiana closed its banks on the twenty-third of February, Maryland on the twenty-fifth, Arkansas on the twenty-seventh, and Ohio on the twenty-eighth. In early March, the contagion spread into Kentucky and Pennsylvania. During February and the first few days of March, close to $2 billion, a third of all the currency in the country, was withdrawn from banks.
A banking panic on such a scale raised the specter of Central Europe in the summer of 1931 when the sequence of banking crises had forced country after country off the gold standard. The domestic run on the U.S banks now provoked a similar international run on the dollar.
The flight from the dollar was exacerbated by suspicions over the incoming president’s currency intentions. Ever since he had been elected, Roosevelt had been floating trial balloons about abandoning gold. In January, he told an emissary from William Randolph Hearst, “If the fall in the price of commodities cannot be checked, we may be forced to an inflation of our currency.” On January 31, his secretary-of-agriculture designate, Henry Wallace, was quoted as saying, “England has played us for a bunch of suckers. The smart thing to do would be to go off the gold standard a little further than England has. The British debtor has paid off his debts 50% easier than the U. S. debtor has.”
Roosevelt was not alone in his talk of devaluation. At least six bills were circulating through the halls of Congress that involved the emergency issue of currency or a change in the value of the dollar. The Frazier-Sinclair-Patman bill provided for government financing of farm mortgages by the issue of Federal Reserve notes without gold backing; the Campbell bill would have allowed issue of full legal tender Treasury notes backed by municipal bonds. Congress was considering one bill to devalue the dollar against gold by 50 percent and another o
ne to reinstate silver as a monetary metal. The most extreme of the measures, the McFadden bill, called for the abolition of the gold standard and the Federal Reserve System and their replacement by a new monetary system based on units of “human effort.”
Hoover had meanwhile convinced himself yet again that the economy had been on the verge of recovery before this last panic hit, which he attributed solely to fears over Roosevelt’s inflationary policies. On February 17, Hoover composed a ten-page handwritten letter and had it delivered by Secret Service messenger to Roosevelt. What was needed to restore confidence, he wrote, was a formal statement from the president-elect pledging himself to a balanced budget and eschewing inflation or devaluation. If Hoover was trying to elicit Roosevelt’s support for preemptive bipartisan action, this was a clumsy, inept, and transparently self-serving way to go about it. Hoover himself admitted in a private letter that it would have involved Roosevelt abandoning 90 percent of his “so called New Deal” program. The incoming president dismissed the letter as “cheeky” and chose simply to sit on it for a couple of weeks.
Until then, panics had mainly affected the smallest banks in the nation. But as the run took on an international dimension, the most important financial institution in the country, banker to its largest banks, the New York Fed became the center of the storm. In the last two weeks of February, it lost $250 million, almost a quarter of its gold reserves. Though the Federal Reserve System as a whole had more than ample gold reserves, had the New York Fed run out of gold and been compelled to call in its loans to banks and shrink its balance sheet in a hurry, this would have created a disastrous situation for the banking system not only in New York but across the country. Theoretically, it could always have borrowed from other Federal Reserve banks in the system—but with every bank in every region under threat, there was no guarantee that its sister banks would have cooperated. There was a real fear that if it became a situation of every man for himself, even the Federal Reserve System might fall apart.
Lords of Finance Page 46
