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bria_27_4A:Layout 1 4/24/2012 12:23 PM Page 1 Bill of Rights Constitutional Rights in Action Foundation SUMMER 2012 Volume 27 No 4 FDR AND THE BANKS

THE U.S. BANKING SYSTEM HAD COLLAPSED WHEN FRANKLIN D. ROOSEVELT (FDR) WAS INAUGURATED PRESIDENT IN 1933. FDR AND CONGRESS MOVED QUICKLY TO RESTORE PUBLIC CONFIDENCE IN THE BANKS. THEN THEY ENACTED MAJOR BANKING REFORMS.

After the stock market crash in

1929, economic conditions in the U.S. Wikimedia Commons worsened into a deep depression. In- ANXIOUS DEPOSITORS MILLED outside a bank early in the . dustrial production slowed steadily, stock prices continued to fall, and un- stat es or the federal government. ated by Congress in 1913, the Fed’s employment went from 4 percent in Most banking was done by role was to stabilize the banking 1929 to 25 percent by 1933. the states, but the federal government system, which had been plagued by Economists have explained a also operated the Sys- numerous bank panics in the 19th number of causes for what became tem, commonly called “the Fed.” All and early 20th century. known as the Great Depression. One federally chartered banks had to be Bank panics could occur when de- is how the banking system operated. members of the Fed. positors believed a bank was in finan- The Fed was governed by 12 Fed- cial trouble. They might hear that the Banking System eral Reserve Banks in different re- bank had made bad investments, or a The banking system consisted of gions of the country and a Federal rumor might circulate that bank em- privately owned banks chartered by Reserve Board in Washington. Cre- ployees had embezzled funds. In a panic, depositors rushed to the bank to demand money from their accounts. FACING CRISES Banks had some money on hand, but This edition of Bill of Rights in Action examines crises — past and present. most of their money was invested or The first article explores the banking crisis, not the recent one, but the one in lent to others. Thus even a sound bank the . The second article examines the Munich agreement, made in the might have trouble paying its deposi- face of the threat of Nazi Germany. The last article looks at our current tors in a panic. A bank might try to crisis and the prospect for future jobs in the U.S. borrow from another bank, but other U.S. History: FDR and the Banks banks might turn it down. Once a World History: Munich and “Appeasement” panic began in one bank, it could Current Issue: Unemployment and the Future of Jobs in America easily spread to others, as people grew unsure about the banking system. If a Guest writer Lucy Eisenberg, Esq., contributed the article on Munich. Our longtime contributor Carlton Martz wrote the other two articles. bank closed, this would be a disaster

U. S. HISTORY

© 2012, Constitutional Rights Foundation, Los Angeles. All Constitutional Rights Foundation materials and publications, including Bill of Rights in Action, are protected by copyright. However, we hereby grant to all recipients a license to reproduce all material contained herein for distribution to students, other school site personnel, and district administrators. (ISSN: 1534-9799) bria_27_4A:Layout 1 4/24/2012 12:23 PM Page 2

for its depositors since no national sys- believed they had no responsibility to their own interests, ignoring how tem of deposit insurance existed as it help them. their bank closures would affect the does today. Depositors would lose all More than 5,000 banks closed rest of the country. By the time De- the money in their accounts. their doors between 1930 and 1932. mocrat Franklin D. Roosevelt was in- One purpose of the Fed was to As a result, public confidence in the augurated president in , serve as the “lender of last resort.” It banking system vanished. every state in had declared was a kind of bankers’ bank, lending some form of bank holiday. money to federally chartered banks in The Banking Crisis of 1933 Between January and March an emergency, such as a bank panic. In 1932, President , 1933, more than 4,000 banks Another purpose of the Federal Re- a Republican, established the Recon- throughout the nation failed. Many serve System was to make sure that pri- struction Finance Corporation (RFC). were small banks, often in farm vate banks chartered by the federal This was a set up areas, that were not members of the government had enough currency (gold to make loans to all banks in trouble Federal Reserve. But even the Wall coins and paper money) to meet the whether they were members of the Street banks, kept afloat by loans needs of commerce. The Fed did this by Federal Reserve or not. from the Federal Reserve, were in regulating interest rates on borrowing During the first months of 1933, danger due to the banking panic that to keep the stable. however, increasing numbers of bank grippedthe entire nation. depositors withdrew and hoarded Fed’s Actions in the Crisis paper currency and gold. More banks The Federal Bank Holiday In 1931 in the midst of the Great failed at a faster rate than the RFC President Hoover had considered Depression, the Fed acted to in- could save. declaring a bank holiday to put the crease interest rates on savings ac- process of reopening the banks in fed- counts. The Fed wanted to eral hands. He doubted, however, that encourage bank depositors to keep Roosevelt realized he had the legal authority to do this, their money in banks and earn inter- so he did not act. est. Many depositors had been de- what Hoover and Two days after Roosevelt was inau- manding their money back in gold. gurated president on March 4, he is- The was on the gold many others failed sued a proclamation that declared a standard. By law, paper money was federal bank holiday. The proclamation backed by gold. The Treasury Depart- to see: The banking also put the federal government in ment could only print money if the charge of reopening the banks. banking system could back it with crisis was mainly The state and federal bank holi- gold. If depositors took gold out of the days had harsh consequences for banks and hoarded it, the paper money about people’s lack most people. They could not cash supply would eventually shrink, de- checks or get money from their bank pressing economic activity. of con@dence in accounts. Some had trouble buying By raising interest rates, the Fed food and other necessities. Others re- affected consumer borrowing. Higher the banks. sorted to writing IOUs or bartering rates meant tighter credit and fewer goods. people could qualify for loans, which In early February, officials from FDR justified his action as neces- further reduced the amount of money the Hoover administration appealed sary to stop future massive bank in circulation. to Henry Ford to lend $7.5 million to withdrawals and hoarding of currency Although designed as the “lender a large Detroit bank where he was a and gold. If this were allowed to con- of last resort” for banks, the Fed was major shareholder. Ford refused. tinue, the circulation of money would designed mainly to keep the big Wall Hoover’s officials, the RFC, and the stall, further crippling the economy. Street banks stable. Almost all the Fed argued over who should stpep u Three days after his proclamation, bank panics in the past had occurred to save the bank. None of them did, FDR sent to Congress the Emergency in New York City. Thus when banks and the bank failed. Banking Act. This act had been began failing outside New York, the The governor of Michigan then or- mainly drafted by Hoover administra- Fed failed to loan money to help the dered a state “bank holiday,” closing tion officials, who had prepared a troubled banks. The Fed concluded it all the banks in his state. This pre- blueprint for closing and reopening could stop the banking crisis by just vented depositors from withdrawing the banks that the former president making loans to the their money. It was a drastic way to never used. banks. This policy worked on Wall prevent banks from collapsing. The act laid out a schedule for re- Street, but banks continued to fail all Several states had already closed opening the nation’s banks after Treas- over the country. Since many of these their banks, and the Michigan bank ury Department examiners evaluated banks were not members of the Fed- holiday stampeded many other states their soundness. Strong banks would eral Reserve System, the Fed leaders to do the same. The states acted in open quickly. Weakened banks would

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receive loans and shipments of Federal Reserve Notes (paper currency). Insol- vent banks would be permanently closed. The act also barred the export of gold to foreign countries. In one day, the solidly Democratic Congress passed the Emergency Bank- ing Act, and FDR signed it. This first law legalized Roosevelt’s proclamation and gave him unheard of authority over the nation’s privately owned banking system.

The First ‘Fireside Chat’ FDR AND PRESIDENT HOOVER rode together to Roosevelt’s first inauguration on March 4, 1933. Roosevelt realized what Hoover and many others failed to see: The banking crisis was mainly about peo- as they had been strengthened. He deposits flowed back into the banks. ple’s lack of confidence in the banks. said, “I can assure you, my friends, On March 14, the Wall Street To restore their confidence, FDR that it is safer to keep your money in Journal headline proclaimed, “Confi- decided to speak to the people di- a reopened bank than it is to keep it dence Back as Banks Reopen.” By rectly over the radio. under the mattress.” the end of the year, most banks were On March 12 at 10 p.m., Roo- He agreed that some bankers operating again and proved to be sevelt spoke live from the White were incompetent or dishonest and solvent or nearly so. Only 5 percent House to an estimated 40 million had used depositors’ money for risky of the banks were closed perma- Americans across the country. A radio speculation and unwise loans. But, he nently due to insolvency. announcer introduced him: “The continued, this was not true about president wants to come into your the large majority of banks. Separating Commercial and home and sit at your fireside for a lit- “And so,” he said, “it became the Investment Banks tle fireside chat.” government’s job to straighten out Public hostility toward all bankers “My friends,” the president began, this situation and do it quickly.” He was high in 1933. Many called “I want to talk for a few minutes with cautioned that a few banks may never bankers “banksters,” after Al Capone the people of the United States about reopen, and some individuals may and other well-known gangsters of banking. . . .” He adopted a conversa- lose their money. the time. tional tone and spoke in plain language Roosevelt concluded by appealing Congress held hearings on “bad aimed at average Americans. He told to the American people to have confi- banking” practices. The hearings them that he wanted to explain what dence again in the banking system: turned up evidence that some banks had been done, why it was done, and We have provided the machinery had used depositors’ money to specu- what the next steps would be to end to restore our financial system, it is late in stocks and other risky deals to the banking crisis. up to you to support and make it increase bank profits. Roosevelt explained the banking work. It is your problem no less Senator (D-Va.) be- system in five sentences. He pointed than it is mine. Together we came the chief critic of these practices. out that “when you deposit money in cannot fail. Glass believed that banks should not a bank, the bank does not put the In response to Roosevelt’s first be collecting deposits from people and money into a safe deposit vault.” In- Fireside Chat, tens of thousands of speculating in the stock market with stead, he said, “. ..the bank puts letters arrived at the White House. their money. He sponsored a bill, your money to work to keep the Most expressed appreciation for backed by FDR, that required banks to wheels of industry and of agriculture Roosevelt’s frank and confidence- choose their form of banking. Banks turning around.” building speech. could be commercial (checking, sav- He described how rushes on When the first banks reopened, ings, and loans) or investment (stocks, banks to withdraw cash or gold were long lines of people formed outside bonds, and financing). caused by the “undermined confi- them. These people were not with- Glass argued that bankers should dence” of the public. He then gave drawing their money; they were de- not put their customers’ money in dan- his reasons for declaring a bank holi- positing their hoarded cash and gold. ger through risky investment schemes. day and how the reopening of the The Treasury Department had In fact, Glass blamed the Great Depres- banks would work. planned a massive printing of Federal sion on the intermingling of commer- He promised that banks with Reserve Notes to meet the banks’ cial and investment banking. “good assets” would reopen immedi- need for cash, but the printing was While bankers had applauded ately, and most of the others as soon not needed since so many voluntary FDR’s federal bank holiday, they

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strongly opposed his support of the allow certain kinds of investment bill to separate commercial and in- banking by commercial banks. vestment banking. They complained In 1999, a Republican Congress that this would hinder raising capital and Democratic president, Bill Clinton, needed to get the economy moving repealed two key sections of the again. Glass-Steagall Act. This repeal elimi- Wall Street banker Jack Morgan, nated most of the remaining barriers son of the founder of J.P. Morgan & Co., that stopped commercial banks from bitterly opposed FDR. Morgan called engaging in investment activities. him the “crazy man in charge.” But After the financial crash in 2008, public opinion opposed the bankers. however, some economists and politi- The Glass bill prohibited commer- cians claimed the repeal of the cial banks from buying and selling Glass-Steagall provisions had led to a stocks and bonds or engaging in most return to high-risk speculation by other investment activities. Only in- large commercial banks. As a result, vestment banks could fully do these the banks faced failure and had to be things. Investment banks, however, bailed outby the U.S. government. FDR Library and Museun could not receive deposits for check- MANY TIMES DURING HIS presidency, FDR Others rejected this view. They ar- ing and savings accounts. addressed the nation on radio in what gued that the mortgage investment came to be known as “.” products that brought on the financial Insuring Bank Deposits crisis were never regulated by the Between 1930 and 1933, deposi- popular support for federal deposit Glass-Steagall Act or were allowed be- tors lost more than $6 billion when insurance was overwhelming. Rep. fore the 1999 repeal took place. almost 10,000 banks failed. In 1933, Steagall introduced a bill that created Instead of restoring the Glass- Rep. Henry Steagall (D-Ala.) champ- the Federal Deposit Insurance Corpo- Steagall , Congress ioned a federal insurance program to ration (FDIC). enacted a new rule that limited com- protect the money people deposited The Steagall bill insured deposits mercial banks’ trading in stocks and in their banks. Deposit insurance, up to $2,500. Any solvent bank (includ- other investments for their own short- Steagall argued, would also stop the ing state chartered banks) could join term profit. panic withdrawals of currency and the FDIC. Member banks paid a small The Federal Deposit Insurance gold that had plagued the banking percent of their insurable deposits into Corporation has been the least con- system for over a century. a common fund from which payouts troversial of FDR’s big banking re- At first, FDR strongly opposed fed- would be made to reimburse depositors forms. His fears about federal eral deposit insurance. He feared that for their losses in failed banks. deposit insurance were never ful- the premiums banks would have to The bill by Sen. Glass separating filled. Today, the FDIC insures de- pay into an insurance fund would crip- commercial and investment banks posits up to $250,000 (one account ple them. He also worried that if the and the one by Rep. Steagall insuring per bank). During the Great Reces- banks’ insurance fund had been used bank deposits were combined into the sion from 2008 to 2011, the FDIC up, the government would be stuck Banking Act of 1933. This is fre- managed the closing of about 400 with compensating insured depositors. quently called the Glass-Steagall Act, banks and made sure that depositors Another argument against federal which FDR signed on June 16. did not lose a penny from their deposit insurance was that it would insured accounts. encourage bankers to act more reck- Banking Reforms Continued lessly. This would happen, the argu- The Banking Act of 1933 gave the For Discussion and Writing ment went, because the government Fed more tools to control the money 1. What did FDR believe was the guaranteed a bank’s depositors their supply and set interest rates on bor- main cause of the banking crisis money even if the banker made risky rowing by banks, which affect con- in 1933? How did he try to solve loans that caused the bank to fail. sumer loan rates. These measures this problem? Do you think he Economists call this situation an were designed to keep the money succeeded? Explain. example of a “moral hazard.” This oc- supply and prices stable. 2. Why did Congress and FDR separate curs when people or organizations are Bankers continued to argue that commercial and investment banks? protected from the bad consequences separating their commercial and in- 3. What is a “moral hazard”? What is of their risky or unwise actions. In ef- vestment functions limited their ability the possible moral hazard of fed- fect, they are saved or bailed out. to finance economic growth. Some eral deposit insurance? Even with Thus, they may be encouraged to take scholars produced studies showing that a moral hazard, do you agree the a chance on repeating the same actions banking in the 1930s were Federal Deposit Insurance Corpo- in the future. overblown by Congress. Over the years, ration is still a good idea? Why or Despite Roosevelt’s opposition, the Glass-Steagall Act was modified to why not?

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For Further Reading Standards Addressed Alter, Jonathan. The Defining Mo- ment: FDR’s Hundred Days and the FDR and the Banks Triumph of Hope. New York: Simon & National U. S. History High School Standard 24: Understands how the New Deal addressed the Great Schuster, 2006. Depression, transformed American federalism, and initiated the . (1) Understands the first and second New Deals . . . . (5) Understands the significance and ideology of FDR and Kiewe, Amos. FDR’s First Fireside the New Deal (e.g., . . . how the New Deal changed the relationship between state and fed- Chat: Public Confidence and the Bank- eral government) ing Crisis. College Station, : National Economics High School Standard 8: Understands basic concepts of United States Texas A & M University Press, 2007. and . (5) Knows that monetary policy refers to actions by the Federal Reserve Sys- tem that lead to changes in the amount of money in circulation and the availability of credit in the financial system. (8) Understands that when banks make loans, the money supply increases, ACTIVITY and when loans are paid back, the country’s money supply shrinks California History Social Science Standard 11.6: Students analyze the different explanations for the Great Depression and how the New Deal fundamentally changed the role of the federal government. Moral Hazards (2) Understand the explanations of the principal causes of the Great Depression and the steps The existence of a possible taken by the Federal Reserve, Congress, and Presidents Herbert Hoover and Franklin Delano moral hazard does not mean Roosevelt to combat the economic crisis. (4) Analyze the effects of and the controversies aris- an action should never be un- ing from New Deal economic policies and the expanded role of the federal government in so- ciety and the economy since the 1930 s . . . . dertaken. It does mean that California History Social Science Standard 12e.3: Students analyze the influence of the federal gov- one should balance the good ernment on the American economy. (4) Understand the aims and tools of monetary policy and of the action against the possi- their influence on economic activity (e.g., the Federal Reserve). ble dangers or unintended consequences. Munich Meet in small groups to National World History High School Standard 39: Understands the causes and global consequences of evaluate the following govern- . (8) Understands the human cost and social impact of World War I . . . . ment actions. First, identify National World History High School Standard 40: Understands the search for peace and stability throughout the world in the 1920s and 1930s. (1) Understands treaties and other efforts to one or more possible moral achieve peace and recovery from World War I . . . . hazards in the action. Second, National World History High School Standard 41: Understands the causes and global consequences of decide if you agree with the World War II. (1) Understands motives and consequences of the Soviet nonaggression pacts government action despite the with Germany and Japan (e.g., the Munich Agreement in 1938 . . . .) (6) Understands the ar- moral hazard(s) involved. Fi- gument that the severity of the Treaty of Versailles caused unavoidable revolt against the na- nally, explain your decisions to tions that imposed it. the rest of the class. California History Social Science Standard 10.6: Students analyze the effects of the First World War. (1) Analyze the aims and negotiating roles of world leaders, the terms and influence of the Treaty of Government Actions Versailles . . . . (2) Describe the effects of the war and resulting peace treaties on population movement, the international economy, and shifts in the geographic and political borders of Eu- 1. To prevent the collapse of the rope and the Middle East. (3) Understand the widespread disillusionment with prewar institu- U.S. banking system, the gov- tions, authorities, and values that resulted in a void that was later filled by totalitarians. ernment makes loans to big California History Social Science Standard 10.8: Students analyze the causes and consequences of banks that invested heavily in World War II. (2) Understand the role of appeasement, nonintervention (isolationism), and the packages of carelessly ap- domestic distractions in Europe and the United States prior to the outbreak of World War II. proved home mortgages. Jobs 2. Congress passes a law that National High School Economics Standard 5: Understands unemployment, income, and income distri- reduces the principal on bution in a . (1) Understands that personal income is influenced by changes in mortgages of homeowners the structure of the economy, the level of gross domestic product, technology, government policies, production costs and demand for specific goods and services, and discrimination. when the current market (6) Understands that the standard measure of the unemployment rate is flawed (e.g., it does value of the home is much not include discouraged workers, it does not weigh part-time and full-time employment dif- less than they owe (so-called ferently, it does not account for differences in the intensity with which people look for jobs). “underwater mortgages”). (7) Understands that many factors contribute to differing unemployment rates or various re- gions and groups . . . . (9) Understands frictional, seasonal, structural, and cyclical unem- 3. The government makes ployment and that different policies may be required to reduce each. loans to poorly managed California History Social Science Standard 12.4e: Students analyze the elements of the U.S. labor auto companies to keep the market in a global setting. (1) Understand the operations of the labor market . . . . (2) Describe industry alive in the U.S. the current economy and labor market, including the types of goods and services produced, and to save jobs. the types of skills workers need, the effects of rapid technological change, and the impact of international competition. (3) Discuss wage differences among jobs and professions, using 4. Congress extends unem- the laws of demand and supply and the concept of productivity. (4) Explain the effects of in- ployment insurance pay- ternational mobility of capital and labor on the U.S. economy. ments to those who have Standards reprinted with permission: National Standards © 2000 McREL, Mid-continent Research for Edu- been out of work for more cation and Learning, 2550 S. Parker Road, Ste. 500, Aurora, CO 80014, (303)337.0990. than six months. California Standards copyrighted by the California Dept. of Education, P.O. Box 271, Sacramento, CA 95812.

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