Lords of Finance: The Bankers Who Broke the World

by Liaquat Ahamed

Fed to jacking up the cost of credit.

Banks were going under in part because the assets they held on their books could not be used as collateral to borrow from the Fed.

Hoover proposed that a new fund of $500 million be created by the larger and stronger private banks to lend to smaller banks on collateral that the Federal Reserve was legally unable to accept.

The bankers were dubious about the idea and kept asking why the government or the Fed did not act—had not the Fed after all been created precisely to avoid such banking panics?

The days of the great Pierpont Morgan, when large banks assumed responsibility for propping up smaller ones and for supporting the integrity of the entire financial system, were long gone.

The bank runs, the spike in currency hoarding, and now the rising cost of money imposed a massive and sudden credit crunch upon an already fragile United States. Between September 1931 and June 1932 the total amount of bank credit in the country shrank by 20 percent, from $43 billion to $36 billion.

loans were called in, small businesses were driven into default. Lenders were forced to absorb losses and in turn lost their own cushion of capital, making depositors quite justly fearful for the security of their money and leading to further withdrawals from banks, which in turn forced more loan recalls and thus more defaults. Though depositors and bankers individually behaved quite rationally to protect themselves, collectively t...

“If there is one moment in the 1930s that haunts economic historians,” writes the economist J. Bradford DeLong, “it is the spring and summer of 1931—for that is when the severe depression in Europe and North America that had started in the summer of 1929 in the United States, and in the fall of 1928 in Germany, turned into the Great Depression.” The currency and banking convulsions of 1931 changed the nature of the economic collapse. As prices fell and businesses were unable to service their debts, bankruptcies proliferated, further chilling spending and economic activity. A corrosive deflationary ps...

Every economic indicator seemed to fall off a cliff—1932 was the deepest year of depression in the United States. Between September 1931 and June 1932, production fell 25 percent; investment dived a stunning 50 percent; and prices dropped another 10 percent, reaching 75 percent of their 1929 level. Unemployment sho...

American corporations, which had made almost $10 billion in profits in 1929, collectively lost $3 billion in 1932. On July 8, 1932, the Dow, which had stood at 381 on September, 3, 1929, and was trading around 150 before the European currency crisis, hit a low of 41, a drop of alm...

General M...

which had traded at $72 a share in September 1929, was now a little above $7. And RCA, which had peaked at...

In 1932, Meyer, having uncharacteristically allowed himself to be hamstrung by the Fed bureaucracy for his first year in office, finally took charge. In January, he persuaded the administration that its attempt to have the large banks voluntarily take responsibility for supporting the system had failed. The Reconstruction Finance Corporation (RFC) was established to channel public money—a total of $1.5 billion—into the banking system.

In February 1932, he pressed Congress to pass legislation that would make government securities an eligible asset to back currency. At the stroke of a pen the gold shortage was lifted, allowing the Fed to embark on a massive program of open market operations, injecting a total of $1 billion of cash into banks. The two new measures combined—the infusion of additional capital into the banking system and the injection of reserves—allowed the Fed finally to pump money into the system on the scale required.

But Meyer had left it too late. A similar measure in late 1930 or in 1931 might have changed the course of history. In 1932 it was like pushing on a string. Banks, shaken by the previous two years, instead of lending out the money used the capital so injected to build up their own reserves. Total bank credit kept shrinking at a rate of 20 percent a year.

On March 12, 1932, the world learned that Ivar Kreuger, the Swedish match king, who had bailed out so many penniless European countries, had shot himself in his apartment on the Avenue Victor Emmanuel III in Paris. At first it was assumed that he was just another victim of the times—he had recently suffered a nervous breakdown and his physician had warned him about the constant strain of his lifestyle on his heart. Within three weeks it became apparent that his whole enterprise had been a sham. His accounts were riddled with inflated valuations and bogus assets, including $142 million of forged Italian government bonds. When the losses to investors were eventually tallied, they amounted to $400 million.

interregnum

bank chain that accounted for 65 percent of the state’s deposits.

It was, however, the run on the Guardian Trust Company of Detroit, a bank controlled by Edsel Ford, scion of the Ford motor family, that transformed the new crisis into a national one.

early 1933, the RFC balked at providing more money unless the sponsors, who were, after all, the second richest family in the country after the Rockefellers, put in more capital. Patriarch Henry Ford, now in his seventies and increasingly autocratic and unreasonable, refused to bail out his son. He had a long-standing antipathy to bankers and could not quite grasp why banks should be allowed to use the money he deposited for making risky loans—“It’s

Faced with a statewide run on its banking system, on February 14, the governor of Michigan issued a proclamation closing all 550 banks in the state for eight days. The residents of Michigan woke up on Saint Valentine’s Day to find that all that they could draw upon was the cash in their pockets.

Across the country, depositors watching the whole monetary system of a major industrial state shut down began pulling their money out of their banks just in case.

During February and the first few days of March, close to $2 billion, a third of all the currency in the country, was withdrawn from banks.

The domestic run on the U.S banks now provoked a similar international run on the dollar.

In order to arrive at what you do not know You must go by a way which is the way of ignorance. —T. S. ELIOT, Four Quartets, “East Coker”

George Harrison,

That morning, long lines of depositors formed outside the reopened banks. But instead of taking their money out, they were putting it back in.

The combination of the bank holiday, the rescue plan, and Roosevelt’s masterful speech—there is no way of distinguishing which was the more important—created one of those dramatic transformative shifts in public sentiment.

On March 15, when the New York Stock Exchange reopened after being closed for ten days, the Dow jumped 15 percent, the largest move in a single day in its history. By the end of the first week, a total of $1 billion in cash—half of everything that had been pulled out in the previous six weeks—had been redeposited in banks. By the end of March, two-thirds of the banks in the country, twelve thousand in total, had been permitted to resume business and the currency hoard in the hands of the public had dropped by $1.5 billion.

The rescue plan may have saved the banking system. But the tasks of getting the factories across the country producing once again and of putting average Americans back to work still remained.

Over the next three months—the celebrated “first hundred days”—Roosevelt bombarded Congress and the country with new legislation. On March 20, Congress passed the Economy Act, which cut the salaries of public employees by 15 percent, slashed department budgets by 25 percent, and cut almost a billion dollars in public expenditures. At the end of March, it approved the creation of the Civilian Conservation Corps to employ young men in flood control, fire prevention, and the building of fences, roads, and bridges in rural areas. In the middle of May came the Emergency Relief Act and that same day Congress passed the Agricultural Adjustment Act, designed to push agricultural prices higher by controlling production and reducing acreage. The Tennessee Valley Authority was set up to build dams and construct public power plants. The National Industrial Recovery Act was passed in the middle of June to permit price fixing. It also authorized $3.5 billion in public works programs. The Glass-Steagall Act, also passed in the middle of June, divorced commercial and investment banking and guaranteed bank deposits up to a maximum of $2,500, while the Truth-in-Securities Act established disclosure provisions to govern the issue of new securities.

Few elements were well thought out, some were contradictory, large parts were ineffectual.

it had little to do with boosting the economy.

This was the temporary abandonment of the gold standard and the devaluation of the dollar.

Dean Acheson,

James Warburg,

Lewis W. Douglas.

The spokesman for Wall Street should have been the head of the Federal Reserve Board, Eugene Meyer. But he found himself completely out of sympathy with the new administration and submitted his resignation at the end of March. As a consequence, Harrison of the New York Fed acted as the primary go-between for bankers and the White House.

His simplistic view was that since the Depression had been associated with falling prices, recovery could only come about when prices began going the other way. His advisers patiently tried to explain to him that he had the causality backward—that rising prices would be the result of recovery, not its cause. They were themselves only half right. For in an economy where everything is connected, there is often no clear distinction between cause and effect.

But once in motion, falling prices created their own dynamic. By raising the real cost of borrowing, they had discouraged investment and thus caused economic activity to weaken further.

George Warren,

You paint a barn roof to preserve it. You paint a house to sell it. And you paint the sides of barn to look at”—although none of his students were quite sure what they meant.

Thomas amendment to the Agricultural Adjustment Act,

ROOSEVELT’S DECISION To take the dollar off gold rocked the financial world.

In 1935, Congress passed a banking act designed to reform the Federal Reserve. Authority for all major decisions was now centralized in a restructured Board of Governors. The regional reserve banks were stripped of much of their powers and responsibility for open market operations was now vested in a new committee of twelve, comprising the seven governors and a rotating group of five regional bank heads, renamed presidents. The secretary of the treasury and the comptroller of the currency were removed from the Board, giving it theoretically even greater independence from an administration. While these measures improved the efficiency of the Fed’s decision-making machinery, they came ironically enough at a time when there were few decisions to take. In 1934, Marriner Eccles, a Mormon banker from Utah, had taken over as the head of the Federal Reserve Board. Scarred by the experiences of running a bank during the Great Depression, Eccles held to the view that with unemployment still high and confidence still weak, the Fed’s prime task should be to keep interest rates as low as possible.

Though the New York Fed lost much of its clout and was now overshadowed by the Board in Washington, George Harrison soldiered on as its president for another eight years. In 1941, he left to become the chief executive the New York Life Insurance Company. During World War II, he was asked by his old friend Henry Stimson, now secretary of war, to become his special assistant for matters related to the Manhattan Project. He served on the Interim Committee, a secret high-level group formed in May 1945 to examine problems related to the creation of the atomic bomb and to advise on its use against Japan. On July 16, after the successful detonation of the world’s first nuclear device in the New Mexico desert, it was Harrison who was the author of the now-famous cable to Secretary Stimson and President Truman at Potsdam: “Operated on this morning. Diagnosis is not complete but results seem satisfactory and already exceed expectations.”

After the war he returned to the New York Life Company. Like so many central bankers, he married late—at the age of fifty-three—to Mrs. Alice Grayson, widow of his old friend Admiral Grayson, who had been Woodrow Wilson’s doctor and accompanied him to the Par...

BREAKING with the dead hand of the gold standard was the key to economic revival. Britain did so in 1931 and began its recovery that year. The United States followed in March 1933 and that proved to be the low point in its depression. France hung on to its link with gold for the longest. In 1935, Clément Moret was fired as governor of the Banque de France for resisting government measures to utilize its gold reserves to expand credit. Only in the following year did France finally abandon the gold standard. It was thus the last of the major economies to emerge from depression.

The exception to this pattern was Germany. After the summer 1931 crisis, it defaulted on reparations and introduced exchange controls. But it never officially left the gold standard. Still obsessed by an archaic fear of inflation, a carryover from 1923, and despite having no gold reserves, Germany decided to act as if it were still on gold, nailing itself to a sort of shadow standard and thereby forgoing the benefits of a cheap currency. When Britain devalued the pound in September, German foreign trade completely collapsed.

succeeded in collecting a grand total of $4 billion from their old enemy.