Banking Panics in the 1930s: Liquidity Crises or Solvency Crises?

Were the banking crises during the Great Depression liquidity crises or solvency crises? Gary Richardson is coming to talk about this tomorrow. I'm looking forward to it:

Gary Richardson and William Troost (2005), "Monetary Intervention Mitigated Banking Panics During the Great Depression: Quasi-Experimental Evidence from the Federal Reserve District Border in Mississippi, 1929 to 1933" http://orion.oac.uci.edu/~garyr/papers/MS_23may2005_final.pdf:

Abstract: The Federal Reserve Act of 1913 divided Mississippi between the 6th (Atlanta) and 8th (St. Louis) Federal Reserve Districts. Before and during the Great Depression, these districts’ policies differed. The Atlanta Fed championed monetary activism and the extension of credit to troubled banks. The St. Louis Fed adhered to the doctrine of real bills and eschewed expansionary initiatives. Outcomes differed across districts. In the 6th District, banks failed at lower rates than in the 8th District, particularly during the banking crisis in the fall of 1930. The pattern suggests that discount lending reduced failure rates during periods of panic. Historical evidence and statistical analysis corroborates this conclusion.

---

Even if the Federal Reserve had tried to alleviate the banking crisis, no clear evidence exists that it could have helped depository institutions. Two schools of thought exist on this issue. One school believes the principal causes of banking crises were withdrawals of deposits, illiquidity of assets, and the Federal Reserve’s reluctance to act. The Fed could have alleviated banking problems by acting as a lender of last resort (Friedman and Schwartz, 1963; Elmus Wicker, 1996). The second school concludes that banks failed because the economy contracted. Asset prices fell. Loan default rates rose. Banks became insolvent, continuing a process of liquidation and consolidation in the banking industry that began during the 1920s. In such circumstances, the Fed could not aid banks by injecting liquidity into the banking system (Temin, 1976; Charles Calomiris and Joseph Mason, 2003)...

[...]

St. Louis was a staunch advocate of non-intervention. Atlanta was a leading advocate of assisting banks in need. The St. Louis and Atlanta Feds applied their different policies to the portions of Mississippi lying within their jurisdictions. The adoption of these policies preceded the onset of the depression, and had little to do with circumstances in Mississippi, which was a small and peripheral portion of each Federal Reserve district, and much to do with the philosophies and experiences of the leadership of the two banks. Thus, the application of Federal Reserve policies to Mississippi possessed the characteristics of an exogenous policy experiment...

[...]

Compounding over the 73 days of the fall ’30 crisis reveals that the panic increased the cumulative hazard for each bank by 11.0%. The fall ’30 crisis, in other words, accounts for approximately one third of the total cumulative hazard experienced by banks in Mississippi between July 1929 and March 1933. Similar calculations reveal the effect of the Atlanta Fed’s expansionary policy during the fall ’30 crisis. Cumulative hazard in the 6th District was 10.2% lower than cumulative hazard in the 8th District. In other words, in the 8th District, where the St. Louis Fed followed the real bills doctrine, the crisis in the fall of 1930 raised cumulative hazard by 11.0%, while in the 6th District, where the Atlanta Fed followed Bagehot’s Law, the crisis increased cumulative hazard by only 0.8%...

Comments

[Anderson]

Over my head, but I wonder about this from 3 n.1:

"The 6th/8th district border divided Mississippi along a line of latitude into regions of equal size with similar industrial, agricultural, and demographic environments."

Virtually the entire Delta falls into the 8th district, placing cotton country squarely into the 8th. (The line appears close to that dividing Miss. into northern & southern federal court districts, except that Holmes & Noxubee Counties end up in the 8th.)

Given that the economy in Miss. at the time could probably be classified between "cotton" and "everything else," this at least makes me wish the authors had backed up that footnote with some sort of authority.

[dryfly]

Anderson hits it on the head... as I was reading the article I was asking the same question... there is no place in America as poor as 'The Delta'... and in the late 20s to early 30s was the center of outflow for the 'Great Migration' after the distaster of 'The Great Flood'...

There maybe more to this story than just banking regulation policy.

[afelton]

Read Table 3... 6th district was 58% cotton, 8th was 80%, unemployment rate and labor supply very similar, portions black and urban very similar... plus, the authors' results hold for +/- 1 degree of latitude of the dividing line. Seems robust to me.

[Anderson]

Thanks, A. Felton--written like one who didn't have to spend the day cranking out discovery responses, and actually got to read the paper.

But I'd like to know where those unemployment rates came from. 1.8%, or even 0.5%, in *1930*????? Wasn't there a Depression on?

[shah8]

I also have problems with the probable existence of capital arbitrage. If the policies were different between 6th and 8th districts, then average guys and bankers may have sought out the banks with ready access to cash. So not only did the other banks have lowered capitalization, they probably lost some to the other banks.

Also, the Atlanta district banks in and around NO probably had much greater access to much larger banks in world financial capitals than the other district, I would say...

Does the paper account for either of these?

[wkwillis]

If you write an economic history of Mississippi in the twenties and thirties and don't mention the fertilisation, mechanisation, petrolisation, hybridisation, and immigration restriction revolutions going on in agriculture at the time, let alone the side effects of the Great Flood, then you are not engaged in economics, you are engaged in literature.

[Anderson]

That's some pretty cool free verse there, Slink, and no more incomprehensible to the layperson than portions of "The Waste Land," to say nothing of the "Cantos."

[Cook]

Cool natural experiment.

But I wonder if the author's are concentrating too much on what happened in the fall of 1930.
I think its clear that easy financing from a reserve bank would make a bank more likely to stay open in the short-run. The relevant questions though are:
1. Did the easy money at the outset of the depression make banks more likely to last over the whole depression? i.e. Whats the district effect on the marginal hazard of closing in the period 1930-38?
2. Did the reserve bank throw good money after bad? Maybe fewer banks went down in the 6th, but the ones that did go down probably took the reserve banks money too. Which district had the highest expected losses?