Introduction to the Great Depression

The Great Depression, one of the most severe economic downturns in history, began in 1929 and lasted through the 1930s. This period was marked by widespread economic hardship, unemployment, and financial instability. A significant contributor to this financial crisis was the extensive failure of banks, which we delve into in this article.

Bank Failures during the Great Depression

During the Great Depression, approximately 9000 banks failed in the United States from 1930 to 1933. The peak of bank failures was in 1933 when around 4000 banks closed their doors. These failures contributed to the financial instability of the era and led to significant reforms in the banking system, including the establishment of the Federal Deposit Insurance Corporation (FDIC) in 1933 to protect depositor funds.

Causes of Bank Failures

One-third of all banks vanished during the early stages of the Great Depression. This was due to a combination of factors, including drastic reductions in bank shareholder wealth, monetary contraction, and deflation. American economists Milton Friedman and Anna J. Schwartz, through their monetarist explanation, argued that the Great Depression was primarily caused by the banking crisis. This crisis led to a reduction of bank credits and a monetary contraction of 35%, which they termed the 'Great Contraction'.

Monetary and Financial Policies

The Federal Reserve's policies played a crucial role in the escalation of the Great Depression. At the time, the amount of credit the Federal Reserve could issue was limited by the Federal Reserve Act, which required 40% gold backing of Federal Reserve Notes issued. By the late 1920s, the Federal Reserve was nearing the limit of allowable credit backed by the gold in its possession.

The Executive Order 6102 made it illegal for private individuals to own gold certificates, coins, or bullion, effectively reducing the pressure on Federal Reserve gold reserves.

The Crash of 1929 and Margin Requirements

The Crash of 1929 further exacerbated the situation. Margin requirements were only 10%, meaning that for every dollar invested, brokers could lend out nine dollars. When the market fell, brokers demanded repayment of these loans, which many investors could not afford. This led to a domino effect as banks faced massive loan defaults and depositors attempted to withdraw their funds en masse, triggering multiple bank runs.

Consequences and Reforms

During the panic of 1929 and through the first ten months of 1930, 744 U.S. banks failed. By the end of the 1930s, a total of 9000 banks had failed. In April 1933, around 7 billion dollars in deposits had been frozen in failed banks or those left unlicensed after the March Bank Holiday.

As borrowers defaulted on debt and depositors withdrew funds, the downward spiral intensified. Desperate bankers called in loans that borrowers could no longer pay, leading to further capital investment and construction slowdowns. The surviving banks became even more conservative in their lending practices, building up their capital reserves and making fewer loans, which further intensified deflationary pressures.

Impact on the Economy

The bank failures had severe impacts on the economy. Outstanding debts became more burdensome as prices and incomes fell by 20-50%, while the debts remained at the same dollar amount. The economy entered a vicious cycle, with each failure leading to a deeper economic downturn.

Conclusion

The extensive bank failures during the Great Depression were a critical factor in the severity of the economic crisis. The failures were a result of a combination of monetary and financial policies, significant economic downturns, and a lack of government intervention to prevent panics and financial instability. These events underscore the importance of robust financial regulation and the role of the Federal Reserve in maintaining stability during economic crises.