looking back – the Depression IV…

Posted on Monday 24 November 2008

While economists treat their discipline as a science, with all the charts, graphs, and numbers that go along with the hard sciences, when they talk, they sound like the softer scientists [paychologists, psychoanalysts] as they describe things like investor behavior, consumer confidence, and risk management – essentially mob psychology. In good times, we are irrationally exuberant. In bad times, we are the opposite – I guess irrationally pessimistic. Such thinking suggests we are rational in between, but from where I sit, it’s kind of hard to support the idea that people are ever rational when large amounts of money are involved. Which brings us to the few years after the Stock Market Crash of 1929. Over the next three years, the Stock Market Indexes continued to fall, losing about 90% of their pre-crash value, accompanied by a rise in unemployment [going from 3.2% in 1929 to 24.9% in 1932].

The term The Depression referred to more than just the failing economy. The mood of the people was depressed – hopeless, helpless, lethargic. They mistrusted the government, the President, their Banks, the Stock Exchange, and probably each other. Much of the economic damage during the Depression came from a type of mob behavior known as a  run on the Bank – when people lose confidence in a Bank’s solvency, panic, and line up to withdraw their money. It’s part of the American holiday ethos to watch the heartwarming story of Jimmy Stewart’s character, George Bailey in the film, It’s a Wonderful Life, the story of a run on a Bank. Banks never have the Capital to cover their Savings Accounts. That’s how Banks work. The interest received on a Savings Account comes from the profits made by loaning money. So, panic leads to a Bank Run. Banks try to raise Capital by calling in Loans, which doesn’t work. And then the Bank fails. In times of panic, individual psychology trumps group psychology every time.

Over the period between the Crash and the 1932 election, there had been recurrent runs on various Banks around the country, and a number of Banks had gone under. In the "lame duck" period between F.D.R.’s election and his inauguration, there was a big run on the Bank in Detroit in anticipation of his inauguration. Bank Runs were the target of his famous inaugural quote, "We have nothing to fear but fear itself." On the day after his Inauguration, he declared a Bank Holiday, shutting down the runs on Banks in their tracks and putting some teeth into his inspiring words.

Banking Regulations: Within three months, Congress passed the Glass-Stegall Act [which became known as The Banking Act of 1933]. This reform legislation had two parts:
  • The Federal Deposit Insurance Corporation [FDIC]: In order to put a stop to the destructive runs on Banks, the Federal Government got into the Insurance business, insuring Savings Accounts for up to $100,000 in case of Bank failure.
  • The Separation and Regulation of Commercial and Investment Banks: This is the part known as regulation. Hearings disclosed obvious conflicts of interest when Banks invest money from their vast holdings in Savings Accounts. So, the Bill imposed strong restrictions on investing by these banks [Commercial Banks]. Likewise, the behavior of Banks that were involved in investing were also heavily regulated. The design here was clear, In the boom before the Crash, Banks had loaned money to people to put in the Market and had invested their assets as well. Glass-Stegall imposed restrictions to stop speculators from using other people’s money. Bank size [merger] was also regulated.
Stock Market Regulation: A series of Legislative acts culminated in the formation of the Securities and Exchange Commission [SEC] in 1934, enforcing regulation of two broad areas:
  • Securities: The Securities Act required any Company that registered a Stock that would be traded across State Lines file an accurate description of its activities and finances on a quarterly basis. There were stiff penalties imposed for fraudulent reporting or accounting. These reports were publicly available [now on the Internet] to allow investors insight into the Companies they were investing in.
  • Stock Exchanges: The SEC was also charged with regulating the Exchanges where Stocks were traded and policing the various New Deal Acts designed to prevent fraudulent trading practices eg insider trading. 
Private Ownership of Gold Bullion: In a contraversial move, F.D.R. confiscated all Gold Bullion in the country by executive order to prevent hoarding [and to allow him to print money to support the recovery effort].

F.D.R.’s early measures marked a radical intrusion of the government into the country’s financial system and stemmed the panic and chaos of the three years since the Crash. The Stock Market came up and the Banking Indistry was stabilized. By this time, however, the country was a wreck with staggering unemployment and large numbers of the homeless. Recovery and Relief Programs were required to begin to to reverse the hard times of families and Indistry [see  looking back – the Depression III…]. What differed between Hoover’s approach to the problem and F.D.R.’s program was the massive amount of control exerted by the Federal Government. The American people were sharply divided over this issue – some casting F.D.R. in the role of a Saint, others seeing him as a Demon. That divide persists to the present.
    January 21, 2010 | 7:51 PM

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