Bank failures: The Early Twentieth Century
After another banking panic in 1907-1908, Congress in 1913 created the Federal Reserve system to furnish an “elastic currency”—Federal Reserve notes, which could expand in supply when members of the public insisted on cashing their bank deposits. National banks were required, and other banks were permitted, to become “member banks,” holding reserves with the Federal Reserve and privileged to borrow from it. The expectation was that banks would borrow newly issued currency to meet panic demands from their depositors.
In 1900, the United States had about 12,000 banks, and that number was rising rapidly, reaching 30,000 in 1921—the all-time peak. Most of these were small banks in small communities. Federal Reserve estimates of bank suspensions averaged 130 per year between 1892 and 1900, despite 491 banks failing in the panic year of 1893. The estimate fell to 81 failures per year between 1901 and 1910 and 94 per year from 1911 to 1920. Then things changed. In 1921-1922, the economy experienced a sharp recession, which was followed by a sustained deflation of farm prices. The failure rate among small rural banks escalated as farm loans went into default. Between 1921 and 1929, a staggering 5,700 banks failed. These failing institutions held about $1.6 billion in deposits, but their depositors ultimately lost only about one-third of this total.
In mid-1929, the U.S. economy entered the worst economic downswing in its history, and bank failures were an important contributing factor. A major New York City bank, the Bank of the United States, failed in December, 1930, unleashing a nationwide run on the banking system. The bank had been heavily involved in stock and real estate speculation. By the time the panic ended in 1933, 9,000 banks holding deposits of $6.8 billion had suspended operations, and their depositors had lost $1.3 billion.
Most of the banks that failed in 1930-1931 had already been in shaky condition when the downswing began, but others were dragged down by deteriorating business conditions. The mass failures depleted the national money supply, which declined from $27 billion in 1929 to $20 billion in 1933. Bank lending declined to the same degree. These factors help explain why the Great Depression was so long and so severe.