COMMENTARY ON BANK FAILURE: THERE WENT INDYMAC – FDIC STEPS IN – WHERE ARE WE GOING WITH FANNIE AND FREDDIE – AND WHO KNOWS WHO ELSE WILL BE IN THE RESCUE LINE?

Summer 1929 – the warning signs were there and the smart money (think of investor Joseph Kennedy, father of the brothers John, Bobby and Teddy and the legendary Bernard Baruch, advisor to presidents) were moving to cash and off to the investment sidelines.  Then came October 1929 – the Great Stock Market Crash and what followed became known forever as the Great Depression.  Bank problems and a growing number of bank failures had a lot to do with both – – the crash and the rapidly declining economy.

 

As we’ve written before in this space, banks are the lifeblood of the American economy – without healthy banks we can’t have a healthy economy.

 

There were many (many!) reasons for the collapse of the stock market after a heady build up in the wildly speculative, “second Gilded Age” of the 1920s; and many more reasons why this nation and then most of the world slipped into a financial black hole and economic chaos that would last a decade or more.  Unfortunate consequences as the world’s economies faltered included the rapid rise of fascism in Italy and Germany and other countries, disrupted global trade and a tragic world war a decade later.  Here in the USA little banks in the rural areas frequently failed as their borrowers (farmers, growers, ranchers) couldn’t repay their loans, and big city banks called the rural bank loans.  (Two disastrous years in the heartland devastated agricultural interests.)

 

By the November 1932 national elections things were really bad; one in four households was unemployed.  Manufacturers’ output were piling up, unsold. Home foreclosures rose dramatically.  Many mortgages were unlike today’s, with our familiar fixed repayment rates (set in years) and were “callable” – no payment, give us your keys.  Deposits were uninsured – banks failed and depositors’ savings disappeared.

 

As things got bleaker, American voters turned to a patrician New Yorker, Franklin D. Roosevelt, who had managed New York (as governor) through the perilous years after the Wall Street meltdown. He took his oath in March 1933 and on March 12th, a Sunday night, he took the “the Radio” (then as new to Americans as the Internet and WWW is today), with the first of his “Fireside Chats” – just the President of the United States and his 40 million or so neighbors.

 

The important subject at hand:  The banking crisis!  The Congress called a special session to deal with banks collapsing and passed the Emergency Banking Act, and now the chief executive was chatting away telling “my fellow Americans” what was going on.  The banks were all now closed – on “holiday” (brilliant messaging, Mr. President), and for the next half hour plus President Roosevelt outlined his plan.  Why the urgency?

 

As FDR explained, “…because of undermined confidence on the part of the public, there was a general rush by a large portion of our population to turn bank deposits into [safe] gold…a rush so great that [even the] soundest banks could not get enough currency to meet the demand…by the afternoon of March 3 scarcely a bank in the country was open to do business…proclamations temporarily closed them in whole or in part had been issued by the Governors in almost all the states…”

 

Three things were now happening:  (1) President Roosevelt issued his proclamation for a national bank “holiday”; (2) the Democrat-dominated congress “promptly and patriotically” confirmed the proclamation and adopted various authorities to develop a comprehensive program of “rehabilitation” of banking facilities. And (3) a series of regulations permitting the banks to continue their functions to take care of the distribution of food and household necessities and payment of payrolls (quoting). Some banks never opened after the holiday; the stronger banks opened quickly.   New currency was distributed. All banks were thoroughly examined, beginning in the Federal Reserve [12] regional cities. Banks got assistance from the Reconstruction Finance Corporation.  Sweeping regulations were adopted to implement the major banking and financial / capital markets “corrective” legislation.  Over the decade of the 1930s American banking was dramatically changed and different.

 

All that was 75 years ago – and as the great philosopher Yogi Berra noted, it’s déjà vu all over again!  Or it seems like it.  Customers have been lining up to get their money out of the [now]failed IndyMac (nation’s largest thrift).  Bankers (no names here, let’s not spread the anxiety) are talking about the liquidity and safety of their institutions.  Some bank stocks are trading so low they are well into short-seller territory and there is cable chatter about stockholders getting shafted but bond holders are probably OK.

 

There was that little sleeper sentence in President Roosevelt’s speech those many years ago:  “The new law allows the Government to assist in making the reorganizations quickly and effectively and allows the Government to subscribe to at least a part of new capital which may be required…”  You bet!

 

Over this weekend we were reading the details of the need for a federal government rescue of the two important “GSEs” – government-sponsored enterprises – Freddie Mac and Fannie Mae.  These are government-sponsored, publicly-traded corporations with complex and unique missions that are believed by the smart money of Wall Street to be fully insured, assured and guaranteed by the feds…in the event they failed financially.  The cost of supporting these vital semi-public, semi-private organizations will be in the many billions, of course.  No institutions this large have ever had to be rescued…unless you count the entire banking industry of the 1930s.

 

During his Sunday night chat with his 40 million or so neighbors (40MM households were said to be tuned in to The Radio) in 1933, President Roosevelt said:  “We had a bad banking situation. Some of our bankers had shown themselves either incompetent or dishonest in their handling of the people’s funds. They had used the money entrusted to them in speculations and unwise loans. This was of course not true in the vast majority of our banks but it was true in enough of them to shock the people for a time into a sense of insecurity and to put them into a frame of mind where they did not differentiate – but seemed to assume that the acts of a comparative few had tainted them all. It was the Government’s job to straighten out this situation and do it as quickly as possible…”

 

Yup, it’s as Larry “Yogi” Berra would say all over again, sounds like déjà vu, no?

 

Before we all panic too much (a little panic is OK and really healthy), let’s keep in mind that there is now FDIC insurance for depositors and IRA accounts; SIPC insurance for brokerage accounts; all arms of the Federal Reserve are on the alert (critics charge the Fed waited far too long to respond after the Great Crash); the capital markets (debt and equity) are very globalized and risk is fairly well spread out; there are “discount windows” and interbank loans and all sorts of structured smoothing mechanisms for bankers; the US Treasury Department under Henry Paulson – a brilliant former Goldman Sachs partner —  is fully engaged in the current crisis; and there are all kinds of safety nets not in place 75 years ago.

 

And there are experienced hands at the wheel:  Our current Fed chairman, Ben Bernanke, edited a book – Essays on The Great Depression – and in his introduction he said: “…I guess I am a Great Depression buff, the way some people are Civil War buffs…I don’t know why there aren’t more Depression buffs.  The Great Depression was an incredibly dramatic episode – an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds gathering ominously in the background all the while…”

 

He goes on:  “Fascinating  and often tragic figures abound, from hapless policymaker trying to make sense of events for which their experience had not prepared them to ordinary people coping heroically with the effects of the economic catastrophe.  For my money, few periods are so replete with human interest…”

 

Wow – calling Professor Berra – Yogi – Yogi – you out there, pal? You hearing this?

 

Folks, do stay tuned – this is also a dramatic episode were are living through and fascinating and tragic figures certainly do abound! (Most of them making far, far more money than their counterparts in the drama of 75 years back.)  As for me, now  I’m going home for a glass of North Fork red and to turn off the news for the day!  Gotta read President Roosevelt’s speeches as the 1930s unfolded.  Right, Yogi?

 

# # #

 

Quotes from “essays on the The Great Depression,” Ben S. Bernanke; Princeton University Press; © 2000; ISBN 0-691-01698-4 – see www.pub.princeton.edu

Leave a Reply

Your email address will not be published. Required fields are marked *