Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (56 page)

Though the meeting continued into the early hours of the morning, he was unable to persuade the few recalcitrants to change their mind. The Fed, believing that it could throw a ring fence around the BUS and prevent its troubles from spreading, decided to close the bank’s doors the next morning. “I warned them
⁶³²
that they were making the most colossal mistake
in the banking history of New York,” Broderick would later testify at a trial. Marcus and one of his lieutenants were tried, convicted, and sentenced to three years’ imprisonment. Broderick was separately indicted for alleged negligence in not closing the bank earlier. The case ended in a mistrial; after a second trial, he was acquitted.

Dramatic as it was, the failure of the Bank of United States was in fact not that unusual. The United States had historically always suffered from an unstable banking system—the consequence of having no central bank compounded by an astoundingly fragmented banking structure. The creation of the Fed in 1913 had more or less solved the first problem, but did nothing to change the organization of banking in the country. During the 1920s, the United States was still populated with some 25,000 banks, many of them so tiny, undiversified, and dependent on the economic conditions of their localities that every year roughly 500 went under. In the first nine months of 1930, as a result of the deepening hard times, 700 had closed their doors. That October, two months before the BUS crisis, the terrible drought across the Midwest and South led to the collapse of the Tennessee investment bank, Caldwell and Company, which controlled the largest chain of banks in the South, leaving a string of failures in its wake—120 in all across Tennessee, Kentucky, Arkansas, and North Carolina.

After closing the BUS, the Fed did successfully manage to avoid a chain reaction among local banks. December 1930 and January 1931 saw a brief spike in bank runs in New York and Pennsylvania, but the sense of panic quickly died down. However, the failure of the BUS did mark a profound change in public sentiment toward banks.

Shaken by such
⁶³³
a high-profile failure, depositors started becoming more cautious about where they placed their money. Unable to tell whether a bank was sound or not, they began pulling their cash indiscriminately out of all banks, good and bad. At first it was a mere ripple—in the months after the twin failures a total of $450 million dollars left the banking system, less than 1 percent of total deposits.

Because of the way banking works, however, such withdrawals had a
negative multiplier effect. In an effort to maintain a prudent balance between their own liquidity and their loan portfolios, banks had to call in three or four dollars of loans for each dollar in cash withdrawn. Moreover, as their loans were called, borrowers in turn withdrew their deposits from other banks. The effect was to spread the scramble for liquidity right across the system. In this climate, all banks felt the need to protect themselves by building up cash reserves and thus called in even more loans. By the middle of 1931
⁶³⁴
, bank credit had shrunk by almost $5 billion, equivalent to 10 percent of outstanding loans and investments.

After a lull during the spring, in May 1931, the bank runs resumed. A real estate bubble in the Chicago suburbs collapsed, and thirty Chicago banks with $60 million in deposits were swept away. Over the summer, the virus spread to Toledo—every large bank but one was shut down; the remaining one being saved only when, at the last minute, trucks from the Federal Reserve Bank of Cleveland drew up at its doors laden with $11
million in crisp new currency notes. Seventy percent of the city’s deposits were frozen, retail business came to a standstill, and even the Inverness Golf Club, scene of the most recent U.S. Open, was closed.

Within the Fed, officials were fully aware of the strains on the financial system—the hoarding of currency, the growing problem of bank failures, the reluctance of banks to lend, prices falling at a rate of 20 percent per annum. Somehow they were unable to put all these pieces of the jigsaw puzzle together. At the Federal Reserve Board, Meyer pressed for a more aggressive policy and even Adolph Miller, who with his natural contrarian streak seemed to end up so often in the minority, joined him. But the Board was legally powerless to initiate action.

Meanwhile, the governors of the various Federal Reserve banks, who could have taken the initiative, refused to act. A large number of the banks in trouble, particularly the small ones, were not members of the Federal Reserve System—only half of the twenty-five thousand banks in the country had joined the system, although they accounted for about three-quarters of all deposits. The regional bank governors did not feel any responsibility for these nonmember banks, despite their impact on the nation’s overall supply of credit.

The real issue for the governors
⁶³⁵
was that many of the banks closing their doors—by one estimate close to half—had sustained such large losses on their loans that they were, like the BUS, insolvent. Determined to follow Bagehot’s rule of only lending to “sound” institutions and believing that propping up failing banks would be throwing good money after bad, the regional governors made it a principle to let them go under. They failed to recognize that by doing so they were undermining public confidence in banks as a repository of savings and were causing the U.S. credit system to freeze up.

Strangely enough in the first quarter of 1931, as the world banking system was having to cope on one side with the hoarding of currency by a frightened American public and on the other by the piling up of gold bullion at the Fed and the Banque de France, the economy went through one of its little rebounds, both in the United States and across Europe. If
the banking system can be compared, as it often is, to the plumbing of the world’s economy, then the double drain of cash was like two invisible leaks. Their effects were not immediate and would only become apparent gradually.

It was during the spring of 1931 after Norman had returned from the United States that he wrote his infamous letter to Moret, foreseeing the wreck of “the capitalist system
⁶³⁶
throughout the civilized world” within a year and asking that his prediction “be filed for future reference.”
^fn3
He could sense that the world’s credit supply was beginning to dry up. But he and his fellow central bankers had been unable to agree among themselves on what to do. Norman found himself increasingly without influence and powerless to act. The letter, a poor substitute for action, was undoubtedly shrugged off within the Banque de France as only old Montagu Norman going on about the end of Western civilization for the umpteenth time.

^fn1
Many popular accounts of the Great Depression attribute a large weight to the protectionist Smoot-Hawley Act as a cause of the economic collapse. Tariffs shift demand from imports to domestic goods, so if anything, it should have had an expansionary effect. Retaliation by foreigners did hurt the U.S. economy, but exports were a small percentage of GDP—less than 4 percent—so the total effect would have been small. Changes in capital flows dwarfed the impact of trade.

^fn2
Schacht liked to tell the story of how when he came to New York in the mid-1920s, Strong had taken him down into the vaults of the New York Fed to show him where the Reichsbank’s gold was stored. Much to Strong’s embarrassment, Fed officials were unable to find the pallet of bullion that had been specifically earmarked for the Reichsbank. See Hjalmar Schacht,
My First Seventy-six Years
(London: Allan Wingate, 1955),
see here
.

^fn3
See here
above.

Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.

—N
APOLÉON
B
ONAPARTE

IN THE SPRING
of 1931, the one major country most weighed down by a sense of collective despair and individual hopelessness was Germany. The official figures indicated that 4.7 million people, close to 25 percent of the workforce, double that in the United States, were without jobs. And this did not include another 2 million forced into part-time work. Pawnshops multiplied as did astrologers, numerologists, and other charlatans. Even before Hoovervilles had become common in cities across America, shantytowns of tents and packing cases had sprung up in the parks and forests around Berlin. These camps, displaying the German gift for organization, soon had their own “mayors,” “town councils,” and community kitchens where women cooked turnips.

But then Germany, burdened by the twin problems of foreign debt and reparations, had been in a constant state of feverish turmoil ever since the
middle of 1929. No sooner had the Young Plan been signed in Paris in July of that year, than the campaign to repudiate it had gone into high gear. A national committee led by Dr. Alfred Hugenberg, chairman of the right-wing German Nationalist Party—third largest in the Reichstag, where it held 73 seats out of a total of 491—was formed to organize a referendum on the plan. Known as the German Randolph Hearst, Hugenberg, a former chairman of the famed arms manufacturer Krupps, had branched out into the news business after the war and now controlled some of the country’s largest papers, including
Der Tag,
the biggest movie production company, and the largest independent telegraph agency.

Among those whom Hugenberg enlisted was Adolf Hitler, then still regarded as something of a joke, a minor figure from a fringe far-right group with an embarrassing past as the leader of the 1923 “beer cellar
Putsch
.” In the previous year’s national elections, the Nazis had won a bare 2.6 percent of the vote and only twelve seats in the Reichstag. They did, however, add their own distinctive brand of venom to the referendum campaign. Arguing that the Young Plan would submit Germany to “three generations
⁶³⁷
of forced labor,” they branded it a “Jewish machination” and “a product of the Jewish spirit.” The referendum, which would have required the government to renegotiate the repeal of the hated War Guilt clause, suspend all payments on reparations, and to make it a crime for any official to enter into any further agreement thereon, received 4,135,000 votes, a sign of the growing popular disenchantment with the policy of fulfillment.

No one provided a better weather vane for the shifting political winds than Hjalmar Schacht. The Young Plan negotiations left him disappointed and bitter. In the late 1920s, he and his old protector Gustav Stresemann had allowed Germany to borrow vast amounts of money from U.S. banks in the hope of forcing American involvement in the reparations question. Their strategy of binding the German republic to American money had, however, not paid off. In Schacht’s view, the American bankers had failed to deliver. He and Stresemann had clearly exaggerated the power and influence of Wall Street to impose a resolution of the reparations issue.

In October 1929, three weeks before the Wall Street crash, Stresemann died suddenly of a stroke at only fifty-one, a victim of stress and overwork. After the grim letdown of the Young Plan negotiations and Stresemann’s death, Schacht lost any remaining faith in the American solution.

He was now in a quandary. Disillusioned with the Americans, he was more willing to explore alternatives, including the unilateral repudiation being advanced by the nationalist right. But it was hard for him to jettison the Young Plan at this stage—after all, the document bore his signature—without looking like a shameless opportunist.

In November, during negotiations at The Hague, the German government agreed to modest adjustments to the Young Plan terms. In return, the Allies agreed to advance the date for withdrawing their remaining troops from the Rhineland, and reached a settlement on the status of German citizens in lands previously part of East Prussia but ceded to Poland at Versailles. The effect of all these modifications was to add some 4 to 5 percent to the Young Plan payments, amounting to about $25 million a year. The economic significance was trivial—nevertheless, it provided Schacht with just the excuse he needed to break with the government.