ILLINOIS BANK FAILURES DURING THE GREAT DEPRESSION
MARK GUGLIELMO
CENTER FOR POPULATION ECONOMICS
UNIVERSITY OF CHICAGO
I would like to thank Randall Kroszner, Robert W. Fogel, Joseph Mason, David Wheelock and
especially Lester Telser and members of the University of Chicago Workshop in Applied
Economics and the Northwestern University Workshop in Economic History and the 2002
Cliometrics Conference in LaCrosse, Wisconsin for their many helpful comments and
suggestions. Any errors are, of course, my own.
Introduction
The Great Depression hit the Illinois and Chicago banking industries hard, as it did in the
rest of the country. On June 29, 1929, there were 1,314 state banks operating in Illinois. Within
four years more than half of them would be out of business. Outside of Chicago, 412 of 1145
banks failed or suspended, meaning that they were forced out of business because they did not
have adequate resources to meet the demands of their depositors. Another 156 went into
voluntary liquidation, paying off their depositors and ceasing operations. In Chicago, 120 of 193
banks failed or suspended outright, with another 24 going into voluntary liquidation. While the
entire U.S. banking system was under great stress during this period, the record in Illinois was
particularly bad. Illinois had a higher number of failed banks than any other state, as well as the
fifteenth highest state bank failure rate in the nation during the Great Depression. Moreover,
most of the states with comparable failure rates were primarily rural and agricultural, with much
less diversified economies than Illinois (see Table 6).
These bank failures had a devastating impact on the economy of Illinois. The deposits of
Illinois state banks that failed or suspended operations from 1929 to 1933 totaled $357 million
(Board of Governors of the Federal Reserve System 1943, p. 288-291). This was equal to more
than one-quarter of the total demand deposits of Illinois on June 29, 1929. According to
Friedman and Schwartz, checkable deposits accounted for approximately 85 percent of M1 in
1929. Thus, if Friedman and Schwartz's figure applies to Illinois, the bank failures directly cost
Illinois depositors an amount equal to 20 percent of the state's money supply in mid-1929. The
loss of this much wealth naturally had a negative impact on consumption, which hurt business,
increasing unemployment and decreasing consumer confidence, thereby leading to further
reductions in consumption. As Bernanke (1983) points out, it also greatly increased the cost of
credit intermediation as many banks with knowledge of small local borrowers went out of
business, depriving these borrowers of their regular source of loans. As surviving banks were
reluctant to extend credit to existing customers, let alone new ones, the supply of credit and
aggregate demand decreased, converting a recession into the Great Depression. Moreover,
checks became suspect as people could no longer be confident that checks written on smaller
banks, particularly those from out of town, were still good, regardless of the creditworthiness of
the person writing the check because so many banks were failing. The decline in the
acceptability of checks as a medium of exchange naturally made transactions more difficult.
1
What made the high number of state banks in Illinois that failed during the Great
Depression even more remarkable was the size of the run necessary for a bank to fail. A large
proportion of the asset portfolios of Illinois state banks were comprised of cash, deposits with the
Federal Reserve, and clearinghouse acceptances backed by the major Chicago banks. The latter
two assets could be converted into cash immediately. Moreover, banks that were members of the
Federal Reserve system could rediscount eligible commercial loans with the Federal Reserve.
Although the Federal Reserve was only allowed to make rediscounts for member banks, many
nonmember banks had correspondent relations with larger member banks. They could thus sell
their eligible assets to these member banks, who could then rediscount these assets with the Fed
directly.
Another asset, loans backed by securities, comprised mainly of stock market call loans,
was also thought to be highly liquid in the 1920s. Loaned on a very short term basis, often
overnight, call loans were the functional equivalent of the current federal funds market (Cook
and LaRoche, 1993). They were also considered to be very safe. In hearings before the
Committee on Banking and Currency, Adolph Miller of the Federal Reserve Board called call
loans on security collateral "the safest loan there is". Senator Carter Glass agreed, saying "I do
not think any loan is ordinarily safer than brokers loans". This opinion was echoed by Roy
Young, the head of the Federal Reserve from 1927 to 1930, who said, "I do not think there can
be any question about the safety of these loans at this time, and of their liquidity" (Meeker, 1930,
p. 632-633). Nevertheless, some connected the banking crisis with the rapid rise in loans backed
by securities during the 1920's and 1930s, and the Federal Reserve encouraged the development
of the federal funds market as a substitute. This along with the prohibition of commercial bank
involvement in investment banking, led to a sharp decline in commercial bank holdings of call
loans after 1933 (Friedman and Schwartz, 1963, p. 445).
Table 1 shows the average portfolio on June 29, 1929 of banks that failed in Illinois from
June 29, 1929 to June 30, 1933. The average bank outside Chicago that failed during this period
had more than 50 percent of its assets in cash, clearinghouse exchanges, deposits with the Fed
and commercial and securities loans, with approximately 83 percent of its liabilities in deposits.
Thus, assuming that all these assets were good and that all other assets were completely illiquid,
the average bank outside of Chicago that failed had to lose 63.2 percent of its deposits to fail.
The average Chicago state bank that failed during this period had about 42 percent of its
2
Table 1: Assets and Liabilities of Illinois State Banks Failing 6/29/29-6/30/33 as of 6/29/29
Outside Chicago
Assets
Cash, clearinghouse exchanges and
due from Fed
US Government Securities
Other loans
Due from other banks
Other bonds and stocks
Real estate loans
Loans on securities
Banking house
Other real estate
Other assets
Total
Liabilities and Equity
Total capital
Demand deposits
Time deposits
Due to other banks
Bills Payable and Rediscounts
Other liabilities
Total
Chicago
All Illinois
2.68%
2.47
34.43
9.31
16.47
15.07
12.91
3.84
1.54
1.28
100.00
5.89%
3.75
15.15
3.70
21.04
17.42
26.27
2.93
0.41
3.44
100.00
4.60%
3.24
22.88
5.95
19.20
16.48
20.91
3.29
0.87
2.58
100.00
13.08%
35.81
46.14
1.18
2.33
1.46
100.00
13.06%
32.55
48.98
0.76
1.19
3.46
100.00
13.07%
33.85
47.84
0.93
1.65
2.66
100.00
Source: Statement of State Banks of Illinois, 6/29/29___________________________________
portfolio in the assets mentioned above, and 80 percent of its liabilities in deposits. Hence, the
average failing Chicago bank had to lose more than 50 percent of its deposits before it failed.
Granted, not all commercial loans were rediscountable by the Federal Reserve, and not all loans
on securities were call loans. But a good portion of the other investments of Illinois state banks
were also highly liquid, even in troubled times. The same is true with deposits held by other
banks, so long as the large banks which held these deposits remained solvent. Further, as
mentioned this analysis applies to both banks that were members of the Fed and those that were
not because member banks would be willing to buy rediscountable assets from nonmember
banks with which they had correspondent relations because they could always rediscount them
with the Fed. Moreover, the Reconstruction Finance Corporation was created in early 1932 to
rediscount the eligible assets of all banks, regardless of membership in the Federal Reserve.
In normal times, most other bank assets are also highly liquid. Holdings of other
securities, and performing loans on securities and real estate could be readily sold. If these assets
3
are included with those already mentioned, an Illinois state bank carrying the average portfolio
of a bank that failed could more than meet all of its deposits. However, during a panic, there was
a large difference between cash and deposits with or assets rediscountable by the Fed and all
other assets. Because the only restriction on Federal Reserve notes printed is that they must be
backed by either gold or eligible assets (i.e., loans that can be rediscounted), the Federal Reserve
can purchase all of the eligible assets presented to it. Thus, the fact that many other banks may be
presenting assets to the Federal Reserve for rediscount does not impair the ability of any single
bank to do so. However, during a panic, many banks may be attempting to sell their holdings of
other securities and performing loans on real estate and securities. Thus, a single bank may only
be able to sell such assets at a large discount, if at all. This problem would only be exacerbated if
many loans that are normally performing go into default because of the Depression. At the same
time, while any single bank could redeem its funds deposited with banks other than the Fed, it
might be difficult if a large number of banks were attempting to do it at the same time. In
Illinois, most interbank deposits were kept in Chicago, where three-quarters of the banks went
out of business between 1929 and 1933. However, most interbank deposit were kept at a few
large Chicago banks which remained solvent.
As can be seen in Figure 1, the number of Illinois state bank failures had started to rise
during the 1920s. Between 1923 and 1927, the number of Illinois state banks failing was greater
than the total number of failures in the entire 35 years since the passage of the Illinois general
banking law in 1887. Moreover, almost three times as many Illinois state banks failed in 1927 as
in any previous year. Regression analysis reveals that during the 1920s, Illinois state banks that
had more capital, that were located in larger cities, that had a higher ratio of retained earnings to
total assets, and that had relatively fewer expensive short term liabilities such as rediscounts and
bills payable were all found to have a lower likelihood of failure (Guglielmo 1998). Controlling
for other factors, Chicago state banks were less likely to fail than other Illinois state banks.
There is also little evidence of severe state banking panics in Illinois during the 1920s;
with minor exceptions, bank failures were not clustered and banks from counties with higher
failure rates were not found to be at a higher risk of failure (Guglielmo 1998). In short, the
experience of Illinois state banks during the 1920s found here is consistent with studies of other
states; failures were largely confined to small, rural banks that relied too much on borrowed
4
0
10
20
30
FIGURE 1: ILLINOIS STATE BANK FAILURES, 1892-1929
1890
1900
1910
Year
1920
1930
or had insufficient retained earnings (see for example Alston, Grove and Wheelock, 1994).
Bank Size
There have been several possible explanations offered for the high failure rates of Illinois
state banks during the Great Depression. One is the proliferation of smaller state banks in Illinois
during the early 20th century. In 1917, the capital requirement for state banks in towns with fewer
than 1,500 inhabitants was lowered from $25,000 to $15,000. During the six years that this
measure was in effect, 707 new state banks, representing almost half of the state banks in
existence in 1929, were created. A 1935 study by the American Bankers Association blamed the
banking crises of the Great Depression partly on a large increase in many states of the number of
banks relative to the increase in population during the 1920s.1 Gambs (1977) finds that states that
had higher increases in the number of banks relative to the population had higher bank failure
rates from 1922 to 1932. But by this measure, Illinois was unremarkable; it had 2,624 additional
1
This problem was largely eradicated by the Banking Act of 1933, which created the FDIC. Since federal deposit
insurance was considered a necessity by most depositors who had faced the banking crises of the depression, and
since membership in the FDIC was subject to agency approval, the Act created a federal barrier to entry in state
banking for the first time (Peltzman, 1965).
5
residents per bank created in the 1920s, barely distinguishable from the national average of 2,728
new residents per new bank (American Bankers Association, 1935). There is some evidence of
overbanking nationally in the years before the Great Depression; the average population per bank
for states in the first, second, third and fourth quartiles ranked by state bank failure rates from
highest to lowest was 4817, 4978, 7028, and 7942, respectively (see Table 6). Illinois had an
average of 4326 residents per bank, significantly below the U.S. average of 5154.
Partly due to the lower capital requirements prevailing between 1917 and 1923, the
average Illinois state bank outside of Chicago had total capital of only $99,000, well below the
national average of $150,000. Since the banks created in this period were also newer than most
other banks, many of them also had less experienced management that had never before faced a
financial crisis. Many of these state banks would fail during the Great Depression. However, as
shown in Table 2, there was little relationship between a bank’s size and its failure rate for state
banks outside of Chicago; if anything, larger banks were slightly more likely to fail. For state
banks in Chicago, only the very largest banks, with capital of $800,000 or more, were less likely
to fail during the Great Depression.
Yet Thomas (1935) found that, controlling for location, smaller banks were not more
likely to fail than larger banks. He argues that what was important was not size but whether the
bank was located in a rural area or an urban area. Since urban areas tended to be more diversified,
Table 2: Relationship between Bank Size and Bank Failures in IL, 6/29/29-6/30/33
State Banks Outside of Chicago
Total Capital
Number of banks
Number of Failures
Failure Rate
Less than $35,000
243
110
41.41%
$35,001-$60,000
197
63
40.14%
$60,001-$100,000
297
120
39.02%
$100,001-$250,000
171
77
46.50%
More than $250,000
234
153
65.38%
Less than $250,000
35
27
77.14%
$250,001-$375,000
43
33
76.74%
$375,001-$800,000
39
34
87.18%
More than $800,000
38
18
47.37%
State Banks in Chicago
6
banks located in urban areas faced less risk than did banks located in rural areas. There is some
statistical evidence to support this argument; the average population per square mile for states in
the first, second, third and fourth quartiles ranked by state bank failure rates from highest to
lowest was 42, 61, 91, and 176, respectively (see Table 6). Thus, the twelve states with the
lowest state bank failure rates had almost four times as many people per square mile as did the
twelve states with the highest state bank failure rates. This pattern did not hold for Illinois,
however; it had a relatively high population per square mile of 136. Moreover, as seen in Table
3, there appears to have been little correlation between population per square mile and failure
rates during the depression for Illinois state banks except for Cook County, which included
Chicago and had a population density of 4268 people per square mile, much larger than that of
any other county.
Table 3: Relationship between Population Density and IL Bank Failures, 6/30-6/33
Population per square mile
Number of banks
Number of Failures
Failure Rate
0 - 35
243
110
45.27%
35.1 – 50
197
63
31.98%
50.1 – 100
297
120
40.40%
100.1-300
171
77
45.03%
Cook County
234
153
65.38%
There is some apparent correlation between the predominance of agriculture and state
bank failure rates; the average ratio of agricultural output to total output in 1930 for states in the
first, second, third and fourth quartiles ranked by state bank failure rates from highest to lowest
was 30.6 percent, 29.5 percent, 21.7 percent and 23.5 percent, respectively. Again, by this
measure Illinois should have done relatively well; it had only 8.8 percent of its total output
devoted to agriculture.
One reason for the poor performance of rural banks was the widespread diffusion of the
automobile, which made it easier for residents of rural areas to go to nearby cities for their
banking needs. The Federal Reserve Board cited this factor in its 1926 annual report:
Some small banks in small communities have found it difficult to make adequate earnings by
conducting their business along strictly conservative lines...The volume of business done by small
banks in rural communities...has diminished in recent years, as the result of improvements in roads and
the widespread use of automobiles, which has led many bank customers to prefer to drive to the county
seat...and to use the facilities of the larger banks in these towns.
7
The automobile also hurt rural agricultural areas because it led to a widespread fall in the
demand for horses and other draft animals as a source of transportation and power. But the
automobile posed the same problem for all businesses located in small towns. There is no reason
to believe that banks in particular would be affected. Moreover, during the Depression in Illinois,
state banks in Chicago had a higher failure rate than did state banks located outside of that city.
Bank Asset Portfolios
Another explanation offered for the high failure rates of Illinois state banks during the
Great Depression has been the deterioration of bank balance sheets, which occurred during the
1920s. As can be seen in Figure 2, the reserve-deposit ratio (cash balances and deposits kept at
other banks divided by the sum of demand deposits, time deposits and deposits due to other
banks) for Illinois state banks fell by more than half in the decade following World War I.
Illinois state banks were also shifting from equity to debt financing at the same time that most
other businesses were shifting from debt to equity financing. As seen in Figure 3, the ratio of
capital to total assets for Chicago state banks fell by about one-third from 1915 to 1925, while
the decline was even greater for Illinois state banks located outside of Chicago.
Although the composition of the assets of Illinois state banks did not change much during
the 1920s, the composition of Illinois state bank loan portfolios changed substantially, as can be
seen in Figures 4 and 5. In 1923 the largest component of state bank loan portfolios was
comprised of commercial loans made to finance agriculture, industry and trade. These loans were
generally short term and many had the further advantage of being good for collateral for loans
(i.e., rediscounts) from the Federal Reserve. But over the 1920s commercial loans dried up both
nationally and in Illinois. A 1936 study by the American Bankers Association attributed this to
large corporations taking advantage of the stock market boom by switching from debt to equity
financing. Between 1923 and 1929, the annual output of commercial paper fell by 60 percent,
from $2.6 billion to $1 billion. During the same period, corporate stock issues rose by almost 900
percent. Indeed, firms not only ceased borrowing, they became lenders themselves. Between
1926 and 1929, the number of New York Stock Exchange loans made by nonbanks more than
quadrupled to almost $3 billion. The ABA concludes that, deprived of their traditional sources of
commercial loans, banks were "forced" into more risky real estate and securities loans. Many
Illinois state banks replaced these lost commercial loans with loans backed by real estate or
8
.15
.2
.25
.3
.35
.4
FIGURE 2: RESERVE-DEPOSIT RATIO FOR ILLINOIS STATE BANKS, 1898-1935
1900
1910
1920
Year
1930
Illinois state banks outside Chicago
1940
chicago state banks
.05
.1
.15
.2
.25
FIGURE 3: CAPITAL-ASSET RATIO FOR ILLINOIS STATE BANKS, 1898-1935
1900
1910
1920
Year
1930
illinois banks outside chicago
9
ilbkccapass
1940
.1
.2
.3
.4
.5
.6
FIGURE 4: LOAN PORTFOLIOS OF CHICAGO STATE BANKS
1920
1925
1930
1935
Year
Real Estate Loans
Other Loans
Loans on Securities
.1
.2
.3
.4
.5
.6
FIGURE 5: LOAN PORTFOLIOS OF STATE BANKS OUTSIDE CHICAGO
1920
1925
1930
Year
Real Estate Loans
Other Loans
Loans on Securities
10
1935
stocks and other securities. These loans tended to be less liquid because they could not be
rediscounted with the Federal Reserve, and real estate loans tended to be for a longer term.
Real Estate Loans
The switch from commercial loans to real estate loans made banks increasingly
susceptible to unanticipated changes in the term structure of interest rates. According to the
expectations hypothesis, long term interest rates are largely determined by expectations about
future interest rates. Thus if it is expected that interest rates will rise in the future, long term
interest rates will be greater than short term interest rates. In other words, the yield curve, which
plots the level of interest rates as a function of term to maturity, will be upward-sloping in this
case. Meiselman (1962) finds that expectations, and hence interest rates, respond quickly to
current (but not previous) errors in forecasting future interest rates. Under such a model, banks
would not be hurt by unanticipated changes in interest rates if the bulk of their assets and
liabilities have short term maturities because interest rates could quickly adjust to forecasting
errors. This was the case in the beginning of the 1920s, when the bulk of bank assets were in
short term commercial loans, hedged against bank liabilities, which were primarily demand
deposits. But if the term structures of assets and liabilities are not hedged so that they become
due at the same time, banks become susceptible to unexpected changes in long or short-term
interest rates. For example, in the early 1970s banks carrying long-term mortgages at relatively
low fixed rates were hurt when the interest rates on their predominantly short-term liabilities
unexpectedly rose.
But during the 1920s bank assets were increasingly concentrated in longer term real
estate loans, while bank liabilities remained the same. Moreover a study by Morton, based on a
survey of commercial banks conducted by the National Bureau of Economic Research, has
shown that the three year moving average of contract length for nonfarm mortgages made by
commercial banks rose from 2.7 to 3.4 years between 1921 and 1925, where it remained in 1929
and 1930 (Morton 1956, p. 175). From January, 1927 until February, 1933, the interest rate on
long term U.S. bonds remained steady, at about 3.5 percent (Banking and Monetary Statistics, p.
469-470). Over the same period, the interest rate on 3 to 6 month Treasury notes fell from 3.23
percent to 0.01 percent (Banking and Monetary Statistics, p. 460). Thus, the premium on longterm debt rose sharply, from less than 0.25 percent in 1927 to almost 3.5 percent by early 1933.
In other words, as the Great Depression worsened, the slope of the yield curve increased.
11
One might think that such a situation would mean a bonanza for the banks. Their long
term real estate loans carried fixed rates substantially above those of their short-term liabilities.
But the reason for the decline in short term rates was a sharp decline in prices, land rents, and
wages. Thus, farmers, landlords, and wage earners all had difficulty in meeting their fixed
mortgage payments. In the 1980s when long term rates fell unexpectedly, mortgage holders were
able to refinance to take advantage of the lower rates. But in the late 1920s and early 1930s, this
option was often not enough because, as we shall see, real estate values plummeted. Thus,
mortgage holders often owed more on the property than it was worth, making it economically
attractive for some to abandon the property altogether rather than refinance.
To help those who wanted to repay their mortgages, banks further amended mortgage
contracts to extend the life of the loan. The average stated length of nonfarm mortgage contracts
for loans made by commercial banks between 1925 and 1929 was 3.7 years, but on average, it
took 8.8 years for borrowers to actually repay these loans (Morton, p. 119). But even with such
incentives, the number of foreclosures rose dramatically. The average foreclosure rate on
mortgages made by commercial banks between 1920 and 1947 was 2.8 percent of the number of
mortgages granted. For mortgages made between 1925 and 1929, this figure is 10.3 percent. Due
to the number of foreclosures and the already depressed price of real estate, foreclosing banks
lost on mortgages granted during these years an average of 24 percent of the original loan
amount on one to four family homes and 34 percent of the original loan amount on all other
property (Morton, p. 111). Even as real estate loans were rising during the 1920s, the Federal
Reserve became increasingly alarmed throughout the period by the increase in stock market
loans. By 1929, these had surpassed commercial loans in New York. This had happened even
earlier for state banks in Illinois, in 1924. The Fed had tried to discourage stock market
speculation by raising the discount rate in 1928, but this had only strengthened the bull market
by attracting from abroad funds seeking higher interest rates.
As might be expected, state banks outside of Chicago made loans backed by farmland
while Chicago state banks made loans backed by residential and commercial buildings. Between
1909 and 1926, the quantity of real estate loans made by Chicago state banks increased by
sevenfold, while real estate loans made by other Illinois state banks went up by nearly fivefold.
Farmers, buoyed by overly optimistic expectations formed as a result of excess demand during
World War I, increased their debts to expand acreage (often onto marginal lands) and
12
FIGURE 6: ESTIMATED VALUE PER ACRE OF FARMLAND, IL AND THE US
50
100
150
200
(1912-1914) = 100
1910
1915
1920
1925
1930
1935
Year
valueil
valueus
10
20
30
40
50
FIGURE 7: FORECLOSURE RATE PER THOUSAND FARMS, US AND IL
1926
1928
1930
1932
1934
Year
foreclosil
forclosus
13
1936
output. In Illinois, the total amount of farm mortgage debt in Illinois increased from $267 million
in 1910 to $711 million in 1924 (Horton, Larsen and Wall 1942, 219-221). This increased debt
became increasingly difficult for farmers to repay as farm prices and land values both fell after
World War I. Between 1920 and 1933, the estimated value of an acre of farmland in Illinois fell
by about two-thirds (Regan and Johnson 1942, p. 4-5). As shown in Figure 6, about half of this
fall came by 1926. The ratio of farm value to mortgage debt in Illinois increased from 8.8
percent in 1920 to 15.8 percent in 1925 (Horton, Larsen and Wall 1942, 219-221, U.S.
Department of Agriculture 1927 Yearbook of Agriculture, Table 511). By 1930, this figure was
43.8 percent (Sixteenth Census of the United States, 1940: Agriculture, Volume III, p. 643).
As a consequence of declining incomes and land values, the foreclosure rate per thousand
farms in Illinois tripled between 1926 and 1933 (Stauber 1931, p. 45; Stauber and Regan 1936, p.
26; Regan and Johnson 1942, p. 4). As shown in Figure 7, the farm foreclosure situation in
Illinois was better than the U.S. average in the 1920s but worse than the U.S. average in the
1930s. The situation in Illinois was unusual because it was one of the more urban states, and as
Alston (1983) points out, farm distress tended to be less acute near urban centers because of
more stable markets and the possibility of nonagricultural employment for farm labor and land.
The worsening agricultural situation naturally had an impact on banks in rural areas. Alston,
Grove and Wheelock (1994), find that rural banks were twice as likely to fail as urban banks, a
fact that they attribute in part to the decline in the price of farm land and output.
There was also a boom in the Chicago real estate market in the years after World War I.
The proportion of real estate loans in the loan portfolios of Chicago state banks increased by 40
percent between 1909 and 1926. Real estate owners could obtain first and second mortgages on
up to 80 percent of the peak value of their property (Hoyt, 1970, p.265). As Robert Rodkey,
writing in 1935, points out, part of the problem resulted from flawed banking practice. In making
real estate loans, the customary practice was to appraise the value of the property and then grant
the loan if the appraised amount provided an adequate margin above the value of the loan. Little
attention was given to the ability of the borrower to meet payments on interest and principal as
during the real estate boom, banks assumed that the value of the property provided adequate
assurance that they would not suffer a loss from defaults (Rodkey 1935, p. 122). For many
banks, this assumption proved to be incorrect. The parallel between this and the banking
problems of the 2000s, also partially brought about by a decline in real estate values, is striking.
14
Moreover, these loans don’t count the $10 billion in real estate bonds issued by Chicago
banks during the 1920s, which allowed individuals to invest as little as $100 in mortgages. The
Chicago banks sold these bonds directly to the public and offered to repurchase them from
dissatisfied customers. As would be expected due to adverse selection, the most undesirable
securities were redeemed, and accumulated in bank portfolios (James, 1938). Unfortunately, we
do not know the real estate bond holdings for individual Illinois state banks. However, Rodkey
(1935) finds that at the end of 1928, for Michigan state banks that failed, real estate bonds
comprised 42.6 percent of their total portfolios of private and government bonds. This figure
represented about 17 percent of the deposits of these banks at the end of 1928. By the end of
1932, 81 percent of all real estate bond issues in Michigan were in default. In February 1933, the
market value of real estate bonds as a class was at most, 25 percent of their par value. While
virtually all bonds did poorly during the depression, no other class of bonds fared so poorly
(Rodkey 1935, p. 33-36). It is unlikely, given the large decline in Chicago real estate values, that
real estate bonds held by Chicago state banks did better than Michigan real estate bonds.
Real estate loans were used to finance a substantial building boom in Chicago. Between
1918 and 1925, there was a 700 percent increase in construction. Although much of this increase
was driven by pent up demand following World War I, building construction in 1925 was still
twice the prewar level. Part of this was driven by an increase in population. According to the
1930 U.S. Census, the population of Chicago increased from 2.7 million to 3.4 million between
1920 and 1930. This helped drive a doubling of apartment rents between 1917 and 1925, while
the rental price of office space more than doubled (Hoyt 1933, p. 377). At the same time,
construction costs actually fell by 20 percent. The value of old two-apartment buildings in all
sections of Chicago increased by two to two and a half times from 1918 to 1926 (Hoyt 1933, p.
239-240). Nevertheless, there is some evidence of overbuilding in Chicago. During the 1920s,
the city’s population increased by 35 percent while the number of new lots subdivided increased
by 3000 percent (Hoyt 1933, p. 237). As late as 1939, there were 2,000,000 subdivided lots in
the Chicago area, enough to accommodate a population of 15 million, nearly three times the
population of the area at the time (Monchow 1939, p. 1). Monchow (1939) finds that, assuming
the same phenomenal growth rate that Chicago had during the previous 60 years, it would take
30 years for all the subdivided land to be utilized. Moreover, Field (1992) argues that because of
poor land development planning in the 1920s, much of the land that was partially-developed in
15
-10
0
10
20
30
FIGURE 8: NEW RESIDENTS PER NEW BUILDING IN CHICAGO, 1900-1930
1900
1910
1920
1930
Year
that decade would be underutilized for years due to physical and legal encumbrances to further
development.
Figure 8, based on a 1933 study by Hoyt, gives the ratio of the annual population increase
in Chicago to the number of new buildings constructed. It shows that in 1920, there were 28 new
residents in Chicago for every building constructed. This fell to 2 new residents per new building
by 1926. In 1927 and 1928, new buildings were going up despite a decrease in Chicago's
population. Of course, some of this new construction might have been to replace depreciated
stock. But even replacement building is discretionary; in 1932 and 1933 combined less than
1,000 new buildings were constructed, representing about 5 percent of the construction of 1926.
As long as building prices and rents could be maintained, borrowers could maintain
payments on their loans, and state bank losses on real estate loans were minimal. But between
1928 and 1933, the rental price of housing in Chicago fell by fifty percent while land values
declined by even more. Depending on location, store rents fell by 40 to 90 percent over the same
period. In the face of rising unemployment and vacancy rates, many borrowers defaulted. The
number of foreclosures in Cook County rose from 3,148 in 1928 to 5,818 in 1930; 10,075 in
16
1931; and 15,201 in 1932 (Hoyt, p. 270). By the end of 1932, deeds amounting to $2 billion were
involved in foreclosures, representing 40 percent of the total land value in Chicago in 1928.
The glut of foreclosures exacerbated the already soft housing market. From 1928 to the
beginning of 1933, the total land value of Chicago fell from $5 billion to $2 billion. The price of
small homes and apartments fell by 50 percent while the value of large apartment buildings fell
by even more. But the largest decline was for vacant lots, which fell by 75 to 90 percent from
their peak prices in 1928. The decline in building values seriously eroded the collateral for loans
backed by real estate. Since borrowers could often get loans for up to 80 percent of the value of
their property, a 50 to 90 percent decline in the value of the property would seriously lower the
banks' power to recover the amount owed upon default. Realizing that little could be gained from
foreclosure, many banks accepted whatever payments their debtors could make. New loans were
almost impossible to obtain, and when they were made they were limited to 10 percent of the
amount loaned on the same property in 1928. Assuming a 50 percent decline in land value, this
would imply a reduction in loans from up to 80 percent of the property's value in 1928 to 20
percent of its 1928 value in 1933.
The difficulty that banks had in disposing of their bad real estate loans can be seen in
.01
0
.005
othreta
.015
.02
FIGURE 9: RATIO OF OTHER REAL ESTATE HOLDINGS TO TOTAL
ASSETS FOR ALL CHICAGO BANKS, 1900-1935
1910
1915
1920
1925
Year
17
1930
1935
their holdings of other real estate. Illinois state law prohibited banks from holding real estate
other than their own place of business except real estate repossessed by banks to satisfy loans in
default (Illinois Auditor of Public Accounts, Banking Law of the State of Illinois 1933, p. 9).
Even this land had to be sold within five years. In Chicago, although other real estate only
comprised 1.4 percent of bank asset portfolios in March 1933, this figure was only about 0.1
percent in 1929, as shown in Figure 9. The total value of Chicago state banks’ holdings of other
real estate, which had only been about one-fifteenth of the value of banking house during the
later 1920s, actually exceeded the value of banking house by 1933. Losses on real estate loans
were exacerbated by the decline in the stock and bond markets, which eroded the value of many
of the loans backed by securities that banks were holding, which had been considered highly
liquid before the depression.
Bank Balance Sheets
In order to determine the importance of the composition of bank assets and liabilities, I
compare the portfolios as of June 29, 1929 of banks that failed over the next four years with
those that remained solvent on June 30, 1933, as published by the Illinois Auditor of Public
Accounts in its Statement Showing Total Resources and Liabilities of Illinois State Banks dated
June 29, 1933. In evaluating the relative importance of balance sheet composition in Illinois state
bank failures, one is aided by the quality of the data that is available. The balance sheets for
Illinois state banks are unusually detailed. They include, for example, data on the composition of
bank loan portfolios, and bank holdings of U.S. government securities.
There have been two general studies that look at the relationship between micro-level
bank balance sheet data and survival during the depression. The first, White (1984) looks at
national bank failures during the banking crisis of 1930. He finds that banks with relatively more
loans and rediscounts to total assets, a lower reserve-deposit ratio, fewer deposits relative to
assets, and more higher-cost borrowed funds relative to total assets all had a higher risk of
failure. Contrary to Friedman and Schwartz, who argue that the banking crisis of 1930 was the
result of a crisis in confidence of the banking system resulting from the failure of the Bank of
United States, White concludes that banks that failed during this period were more similar to
those that failed in earlier years when there were no crisis of confidence than to those that failed
in subsequent years. More recently, Calomiris and Mason (2003) look at Federal Reserve
member banks. They find that banks that were smaller, relied more on borrowed funds (bills
18
payable and rediscounts), held more of the deposits of other banks, and made relatively more
loans were all more likely to fail. Like White, they conclude that bank failures were more likely
the result of relatively weak balance sheets than a crisis of confidence in the banking system.
There have been three published studies that have related the failures of Chicago state
banks to balance sheet items. The first, Thomas (1935), compares the June 29, 1929 balance
sheets of Chicago banks located outside of the Loop that failed during 1931 with those that were
still in operation on July 1, 1934. He finds that failing banks made more loans on real estate, had
relatively more of their assets invested in the bank building, fixtures and other real estate, had
accumulated smaller surpluses and retained earnings, and were in operation for a relatively
shorter time than banks that remained solvent. He concludes that "faulty management rather than
external circumstances is the major cause for bank failures" (p. 316).
Esbitt (1986) also blames poor management for Chicago state bank failures that occurred
during 1931. He finds that banks failing during 1931 had a lower ratio of reserves (defined as
cash and equivalents, amounts due from other banks, and United States government securities) to
deposits, relatively more borrowed funds (rediscounts and bills payable), and assets in banking
house and furniture, and relatively lower retained earnings than banks that remained solvent. He
does not find similar results for banks failing in 1930 and 1932.
Most recently, Calomiris and Mason (1998) compare the balance sheets of banks that
failed during the June, 1932 Chicago bank panic with those banks that failed in 1932 before the
panic and those that remained solvent to determine if depositor confusion about the value of
bank assets caused solvent banks to fail. They find that banks that failed during the panic had
lower market values to book values, lower ratios of reserves to demand deposits, lower ratios of
retained earnings to net worth, and higher proportions of long term debt. They conclude that
banks that failed during the July 1932 crisis had more in common with other banks failing during
1932 than with solvent banks, and that the crisis was not caused primarily by depositor confusion
over which banks were solvent.
Although all of these studies are useful, they all concentrate on Chicago. Thus data for 85
percent of the banks in Illinois, the second largest state banking system in the country, has been
largely unexploited. Moreover, these studies look at only brief periods of the Great Depression,
concentrating on the two banking panics in Chicago, in June 1931 and June 1932. This paper
19
studies the entire state banking system in Illinois from the stock market crash in 1929 until the
bank holiday of 1933, after which stability was finally restored to the nation’s banks.
Table 4 compares the June 1929 balance sheets of banks that remained solvent with those
that either failed by June 1933 or were still under suspension following the bank holiday in
March of that year. I compare banks in Chicago and the rest of Illinois separately, and perform a
two-sample t-test assuming unequal variances on the means of various balance sheet variables to
see if there is a difference in the means of these variables for banks that failed and those that
remained solvent. Surviving state banks in Chicago had ten times as much capital as did failing
banks on average; outside of the city there appears to be little difference in the average capital of
surviving and failing state banks. For both Chicago banks and those outside the city, solvent
banks had a higher reserve-deposit ratio and more capital relative to debt than did failing banks.
Chicago banks that survived held relatively more U.S. government bonds, while banks that failed
relied more on other security investments; surviving banks outside of Chicago held relatively
more securities of all types than those that failed. Failing banks throughout the state spent
relatively more before the depression on their place of business and furnishings (banking house)
and relied more heavily on borrowed funds (bills payable and rediscounts).
I look at real estate loans both in 1929 and in 1926, at the height of the Chicago real
estate boom. For Chicago banks, failing banks had higher real estate loans in both 1926 and
1929, but the difference was greater in 1929. But for banks outside Chicago, solvent banks had
relatively more real estate loans in their portfolios in both 1926 and 1929, although the difference
between the classes of banks is not very high in either year. However, banks outside Chicago did
hold relatively more real estate other than their own bank building. Most of these holdings would
have been foreclosed property that banks were waiting to dispose of. In Chicago, solvent banks
actually made more loans backed by collateral security than did banks that failed, indicating that
these loans did not increase the riskiness of banks. Outside of Chicago, failing banks actually
made slightly more loans backed by collateral securities than did banks that remained solvent.
Finally, for all state banks, surviving banks had higher retained earnings, indicating either that
they were historically more profitable or invested relatively more of their earnings back into the
business.
To check banks exposure to the term structure of interest rates, I look at the ratio of time
deposits, which tend to be held by banks for a longer term than demand deposits, to both total
20
loans and real estate loans, which tend to be longer term assets that aren’t as liquid as securities,
particularly U.S. government securities. These ratios can therefore be thought as proxies for the
ratio of long-term debt to long-term assets. One would think the higher that this ratio is, the more
secure a bank would be. The only great difference in these ratios is that surviving state banks in
Chicago held almost 23 times more time deposits than real estate loans, while failing Chicago
state banks only held about 4 times more time deposits than real estate loans.
For all Illinois state banks, surviving banks held more deposits from other banks in June
1929, indicating that bankers knew which banks were at higher risk before the depression. It
would be interesting to see if depositors also knew ex ante which of the banks were at higher risk
to fail. If depositors think that a bank is at increased risk to fail, they can move their deposits to
other banks that they perceive as safer. Banks losing funds can respond to this by increasing
interest rates on deposits to stem the outflow. Strahan (1993, 1995) finds that during the 1980s
financially weak thrifts paid higher interest rates on certificates of deposit than healthy thrifts
even with the presence of FSLIC insurance, partly because depositors did not fully trust the
government to make good on lost deposits in a timely fashion, if at all.
But for Illinois state banks in the 1930s, there was no deposit insurance of any kind.
Surely if 1930s depositors suspected that a bank was financially unsound, the market would have
extracted a greater risk premium than weak thrifts had to pay in the 1980s. Calomiris and Mason
(1998) find that Chicago state banks failing in 1932 paid higher interest rates than banks that
remained solvent. However this is mainly due to the composition of their debt; failing banks had
relatively more time deposits, bills payable and rediscounts, for which interest rates are relatively
high, than did solvent banks. Calomiris and Mason do not find that failing banks actually paid
higher interest rates on demand deposits. Benston (1964) finds that, for the period from 1929 to
1935, city banks that failed paid higher interest rates on demand deposits than banks that
survived. Country banks that survived actually paid higher interest rates on demand deposits than
banks that failed. Benston argues that one explanation for this is that strong solvent banks may
offer higher interest rates on demand deposits in troubled times to keep depositors from
withdrawing their funds.
An alternative explanation for the lack of a relationship between a perceived higher risk
of failure and higher interest rates on demand deposits is offered by Gorton and Pennacchi
(1990). They argue that if bank depositors are very risk averse, they will not accept any increased
21
risk on their deposits, regardless of the risk premium. Therefore, if they suspect that a bank is
even slightly more likely to fail, they will immediately withdraw their funds. Thus, if a bank’s
perceived strength changes, it will be reflected as a change in its deposits rather than as a change
in its interest rate. The result, in the absence of deposit insurance, is a bank run. During a bank
run, depositors rush to withdraw their deposits because they expect a bank to fail. During a bank
run there is a significant advantage to being one of the first depositors to withdraw their funds
because those who attempt to withdraw their funds first are more likely to get the full value of
their deposits, thereby avoiding losses should the bank fail. However the sudden withdrawals can
force banks to liquidate many of its assets at a loss, thereby increasing the probability of failure
(for a more formal presentation of this theory, see Diamond and Dybvig, 1983). An alternative to
deposit insurance to prevent runs would be for commercial banks to adopt the practice of closedend mutual funds, whereby investors who wish to retrieve their funds sell their shares in the fund
at whatever price the market will bear.
Calomiris and Mason find that Chicago state banks that failed in 1932 suffered larger
withdrawals during 1931 than banks that remained solvent. To test these results on a statewide
level for the entire depression, in Table 5, I compare the change in deposits from June 29, 1929
to December 31, 1930 (before the banking crisis began in earnest) of banks that failed between
January 1, 1931 and June 29, 1933 with those that remained solvent. This was before the real
banking crises; only fifteen percent of the banks that failed from June 1929 to June 1933 failed
during these eighteen months. My results show that for state banks outside of Chicago, solvent
state banks retained a higher percentage of their demand and time deposits that those that failed.
Banks outside of Chicago that survived the depression increased their holdings of the deposits of
other banks fivefold during the first year of the depression, while banks that would fail actually
saw these deposits decline. For Chicago state banks, there appears to be little difference in the
change in the public’s holdings of time and demand deposits for either banks that survived until
June 1933 or for banks that failed between January 1931 and June 1933. Chicago state banks that
failed between 1931 and 1933 actually saw their deposits of other banks increase between June
1929 and the end of 1930. This might have been an attempt by stronger banks to shore up weaker
banks.
22
TABLE 4: CHARACTERISTICS OF FAILING AND SOLVENT BANKS (6/29/29)
State Banks in Chicago
Solvent, 6/29/33
Total capital
Failed@, 6/29-6/33
$5,532,168
$543,810
($3,321,081)
($49,785)
Reserve-deposit ratio
.181 (.021)
.157 (.012)
Capital to total assets
.215 (.035)
.159 (.008)
*U.S. government bonds to total assets
.088 (.032)
.026 (.004)
*Other bonds and stocks to total assets
.174 (.023)
.223 (.013)
**Real estate loans to total assets, June 1929
.126 (.019)
.178 (.008)
Real estate loans to total assets, June 1926
.144 (.025)
.176 (.008)
.304 (.027)
.250 (.010)
Other loans to total assets
.144 (.023)
.145 (.010)
***Banking house to total assets
.020 (.004)
.041 (.004)
Other real estate to total assets
.003 (.002)
.004 (.001)
Debt to equity
6.19 (.536)
6.46 (.247)
.018 (.006)
.004 (.001)
.550 (.039)
.598 (.015)
**Bills payable and rediscounts to total assets
.005 (.002)
.012 (.002)
**Retained earnings to total assets
.023 (.005)
.012 (.001)
.839 (.129)
.974 (.076)
22.85 (16.51)
3.86 (.487)
49
120
$97,715 ($5,576)
$103,495 ($7,409)
***Reserve-deposit ratio
.197(.007)
.163 (.003)
***Capital to total assets
.178 (.004)
.164 (.004)
***U.S. government bonds to total assets
.035 (.002)
.017 (.002)
**Other bonds and stocks to total assets
.142 (.006)
.122 (.006)
Real estate loans to total assets, June 1929
.123 (.004)
.115 (.004)
**Real estate loans to total assets, June 1926
.134 (.005)
.120 (.004)
*Loans on securities to total assets
**Due to banks to total assets
Time deposits to total deposits
Time deposits to total loans
Time deposits to real estate loans
Number of banks
State Banks Outside Chicago
Total capital
23
Loans on securities to total assets
.075 (.004)
.083 (.004)
***Other loans to total assets
.424 (.007)
.461 (.009)
***Banking house to total assets
.034 (.001)
.044 (.002)
***Other real estate to total assets
.012 (.002)
.021 (.002)
***Debt to equity
5.50 (.099)
5.96 (.126)
**Due to banks to total assets
.005 (.001)
.003 (.001)
**Time deposits to total deposits
.457 (.009)
.486 (.010)
***Bills payable and rediscounts to total assets
.013 (.002)
.027 (.002)
***Retained earnings to total assets
.020 (.001)
.014 (.001)
Time deposits to total loans
.658 (.021)
.656 (.023)
Time deposits to real estate loans
5.90 (.509)
5.59 (.406)
576
411
Number of banks
@Failed banks include banks suspended under 1933 bank holiday as of 6/29/33
Standard Errors in Parenthesis
*Significant at the 10 percent level
**Significant at the 5 percent level
***Significant at the 1 percent level
___Source:_Statement of State Banks of Illinois, 6/29/29___________________________
TABLE 5: RATIO OF 12/31/30 DEPOSITS TO 6/29/29 DEPOSITS
Solvent, 6/29/33
Failed, Jan. 1931 – June 1933
Time deposits
.874 (.131)
.896 (.167)
Demand deposits
.777 (.068)
.738 (.025)
Due to banks
.825 (.177)
1.549 (.570)
Solvent, 6/29/33
Failed, Jan. 1931 – June 1933
1.096 (.098)
.873 (.013)
.838 (.015)
.801 (.015)
5.691 (3.521)
.733 (.120)
State Banks in Chicago
State Banks Outside Chicago
**Time deposits
*Demand deposits
Due to banks
*Significant at the 10 percent level
Source: Statement of Illinois State Banks, 6/29/29 and 12/31/30___________________________
24
The Illinois Banking Environment
The remarkable thing about the Illinois banking industry during the Great Depression was
that it did so poorly despite the state’s relatively urban and diversified economy. As can be seen
in Figure 10, the failure rate for Illinois state banks was actually below the national average for
all state banks in the United States during the 1920s. But Illinois state banks clearly fared worse
during the Great Depression than did state banks in the rest of the country, with a failure rate of
47.35 percent, the 15th highest state bank failure rate in the U.S. during the Depression. Chicago
state banks did even worse than state banks located outside of the city. It would be useful to see
if there was something about Illinois, such as the state’s regulatory, economic or demographic
environment, that was responsible for the poor performance of Illinois state banks during the
Depression. This information is presented in Table 6.
State banking systems operated under a variety of different regulatory regimes, with
varying regulations regarding minimum capital requirements, reserve requirements and branch
banking. White (1983) argues that state banking authorities competed with federal authorities to
attract banks to their systems with more lax regulatory practices to the detriment of the stability
0
.1
.2
.3
FIGURE 10: FAILURE RATES FOR US AND ILLINOIS STATE BANKS
1920
1925
1930
1935
Year
illinois state bank failure rate
US state bank failure rate
25
Table 6: State Failure Rates and the Banking Environment
State
Failure
Rate
Minimum
Branches
Reserve
Pop per Pop per Emp1930/ PCI1930/
Capital
Legal
Require- square
bank
Emp1933
PCI1933
(000)
ment (%) mile
Arkansas
73.90%
0
Prohibited*
15
35.3
4490
79.3%
47.0%
Nevada
68.00
10
Prohibited
15
0.8
2602
71.8
58.5
Iowa
65.93
25
Prohibited
15
44.5
1974
86.1
54.0
Michigan
64.65
20
Limited
12
84.2
6535
78.2
46.5
North Carolina
59.02
5
Statewide
15
65.0
7339
95.3
60.3
South Carolina
58.23
0
Statewide
7
57.0
8482
93.1
60.9
Wisconsin
57.16
10
Prohibited*
12
53.2
3084
74.4
53.0
Nebraska
57.12
10
Prohibited*
15
17.9
1716
85.4
57.4
Arizona
56.25
&
Statewide
15
3.8
9469
63.3
53.1
Indiana
52.97
25
Prohibited*
12.5
89.8
3770
74.2
51.7
Mississippi
52.94
10
Limited
15
43.4
6547
79.8
47.0
South Dakota
50.34
10
Law silent#
17.5
9.0
1795
87.4
50.0
Maryland
48.15
10
Statewide
15
164.1
7585
87.3
64.3
Florida
47.73
15
Prohibited
20
26.8
6301
97.1
55.5
Illinois
47.35
25
Prohibited
15
136.2
4326
76.6
48.2
Missouri
45.38
10
Prohibited
15
52.8
2840
84.9
54.8
Colorado
45.10
10
Prohibited
20
10.0
3794
72.5
58.3
North Dakota
44.21
10
Law silent#
20
9.7
1483
88.2
48.6
Louisiana
41.88
10
Limited
20
46.3
9340
80.2
56.6
West Virginia
41.76
25
Prohibited
10
72.0
5822
88.9
56.2
Oregon
40.71
10
Prohibited*
15
10.0
4076
85.2
52.3
Idaho
40.43
10
Prohibited
15
5.3
3248
78.0
54.4
Oklahoma
40.12
10
Law silent#
15
34.5
3890
78.8
49.6
Ohio
40.06
25
Limited
15
163.1
7026
76.0
52.8
Alabama
38.59
15
Prohibited*
15
51.6
7604
78.6
44.0
Maine
38.30
&
Limited
15
26.7
7974
92.7
64.3
Washington
36.32
10
Prohibited*
15
23.4
4612
78.9
53.3
Utah
35.71
10
Prohibited
15
6.2
4883
74.9
55.2
Minnesota
33.03
10
Prohibited*
12
31.7
2463
85.4
58.8
Montana
28.91
20
Prohibited
10
3.7
2757
68.2
52.9
Pennsylvania
28.61
25
Limited
15
214.8
6387
83.2
53.7
Tennessee
27.86
&
Limited
10
62.0
5417
80.8
52.1
Virginia
27.33
10
Statewide
10
60.2
5276
90.4
59.0
California
26.52
25
Statewide
12
36.5
13051
80.6
57.7
Georgia
25.84
15
Prohibited*
15
49.5
7181
86.7
56.0
Massachusetts
23.53
100
Limited
15
528.6
16731
85.7
63.5
Kansas
23.20
10
Prohibited
15
23.0
1766
88.9
54.1
Kentucky
22.56
15
Limited
7
65.1
4603
83.4
51.2
Connecticut
22.22
&
Prohibited
12
333.4
9981
83.3
58.3
New Jersey
18.64
50
Limited
15
537.8
7540
85.8
58.6
Texas
17.31
10
Prohibited
12
22.2
4453
80.7
56.7
New Mexico
17.24
30
Prohibited
12
3.5
7559
76.5
61.9
New York
14.44
25
Limited
12
264.2
13392
90.9
58.8
Wyoming
13.33
10
Statewide
20
2.3
2654
74.9
58.2
New Hampshire
13.33
&
Law silent#
15
51.5
6553
87.4
63.2
Vermont
12.82
&
Law silent#
15
39.4
4231
87.6
58.8
Rhode Island
6.67
&
Statewide
15
644.3
27500
85.6
63.4
Delaware
6.67
&
Statewide
10
121.8
5072
89.5
57.1
US average
41.94
17
14.25
92.5
5154
84.7
55.4
& Set by each bank’s charter of incorporation
# Law silent, but no branches in the state
*Banks with existing branches at the time the law was passed were allowed to keep them
26
Agricul/
Total
Output
54.25%
33.79
44.87
6.43
20.00
30.07
17.44
48.91
24.78
12.36
56.56
70.85
8.30
36.46
8.79
18.23
36.26
79.91
20.32
15.23
26.38
57.05
40.33
6.40
29.64
21.29
21.65
23.05
28.52
32.99
4.73
25.03
23.07
18.95
28.56
2.38
36.81
31.84
4.37
2.65
34.65
74.91
4.25
38.66
9.25
29.62
1.58
13.63
14.63
of the national banking system. There is some evidence that more lax regulatory requirements
may have contributed to instability of state banking systems. For example, it appears that states
with lower minimum capital requirements had higher failure rates during the Great Depression.
Table 6 presents the minimum capital requirements for the various states as reported by White
(1983). The average (unweighted) failure rates for states with capital requirements of $10,000 or
less was 44 percent, about ten points higher than the state bank failure rate for states with capital
requirements of $25,000 or more. Mitchener (2005) finds that counties in states that had higher
minimum capital requirements had lower failure rates for state banks that were not members of
the Fed.
Illinois was one of the few states that was silent on minimum required reserves, but the
state auditor issued an odd ruling in 1917 that required state banks outside of Chicago to keep
cash, cash equivalents and deposits with other banks equal to fifteen percent of deposits. For
Chicago, this figure was 25 percent. It would seem that two banks could collude, keeping their
reserves in each other's banks, with very little actual cash to satisfy depositors' demand between
them. Moreover, Charlton (1938) argued that the state auditor could do nothing to legally enforce
this ruling, and there were no penalties if the reserve requirement was not met. His argument is
bolstered when it is found that 35 percent of all state banks outside of Chicago and 93 percent of
the state banks in Chicago did not meet these requirements in June, 1929.
But does the presence of reserve requirements actually increase the liquidity of the
banking system? In a 1931 report, the Federal Reserve Board argued that required reserves were
no longer necessary for liquidity because, "since the passage of the Federal Reserve System, the
liquidity of an individual bank is more adequately safeguarded ...by providing for the rediscount
of their eligible paper than by the possession of legal reserves" (Goodfriend and Hargraves,
1983, p. 5). After this time, the primary purpose of reserve requirements appears to have been as
an instrument of monetary control. Moreover, as Telser (2007) points out, the only cash reserves
that are actually useful to banks in meeting depositor demands are excess reserves. To see this,
consider the following example. If a bank were required to keep 100 percent of its deposits on
reserve in the bank's vaults, a reduction in deposits would reduce required reserves by an equal
amount, automatically keeping the bank in compliance with the reserve requirement. However,
this is not the case with a fractional reserve system. For example, if a bank is required to keep 25
percent reserves on $100 in deposits and has no excess reserves, if $10 is withdrawn the bank
27
falls $7.50 short of required reserves. If a bank were forced to meet this shortfall by selling good
assets or calling in performing loans at a loss in an unfavorable market, the reserve requirement
may do depositors more harm than good.
However, because there was no state regulation that effectively required Illinois state
banks that were not members of the Federal Reserve System (about 95 percent of all Illinois state
banks) to carry reserves, for most Illinois state banks, all reserves were excess reserves. The only
thing besides prudence that would force a nonmember Illinois state bank to keep reserves would
be competition from other Illinois state banks. The assets and liabilities of Illinois state banks
were a matter of public record, published periodically by the Illinois auditor of public accounts.
Further, the Chicago Tribune periodically published the assets and liabilities of all Chicago state
banks. Hence, if any state bank were carrying an unusually low number of reserves, worried
depositors could respond by moving their funds to another bank since, before the creation of the
FDIC, reserves had been depositors’ primary assurance that banks would be able to meet
depositor demand in a tight money market.
Table 6, which shows reserve requirements for the various states as reported in the
November 1928 Federal Reserve Bulletin, shows little correlation between a state’s reserve
requirement and its failure rate for state banks; the average reserve requirement for state banks in
the first, second third and fourth quartiles ranked by failure rates from highest to lowest was 14
percent, 16 percent, 13 percent and 13 percent, respectively. Mitchener (2005) actually finds that
counties in states with higher reserve requirements may have had higher state bank failure rates,
possibly because higher reserve requirements might induce banks to increase the share of risky
assets in their portfolios in order to increase expected returns.
The Illinois Banking Act of 1887 was also silent on branch banking. However, in
response to a questionnaire sent out by the U.S. Comptroller of the Currency in 1895 pertaining
to state banking laws, the auditor of Illinois reported that in practice branch banking was not
permissible. This opinion was affirmed by a ruling by the state attorney general in 1898.
Although branch banking in Illinois was not specifically prohibited until 1923, no Illinois state
bank ever opened a branch.
The main reason for the prohibition on branch banking in Illinois was the opposition of
the Illinois Bankers' Association, which was dominated by small unit banks. It argued that
branch banking would permit a few of the large Chicago banks to monopolize the state's banking
28
industry. But as early as 1902, the Chicago Banker refuted this argument, "contending that any
`money power' that would develop `would not approach the tyranny of the local money power
which now exists in many places where there is but a single local bank'" (Charlton, 1938). The
result of the prohibition on branch banking was a plethora of small banks, many in rural towns.
Many of the banks were poorly diversified, with most of their assets in real estate loans to local
farmers. Branch banking might have lessened the risk of holding real estate and other loans by
allowing banks to diversify geographically. A recent study found that in the 1980s, banks in
states where branch banking was permitted statewide had more diversified bank loan portfolios,
with rural banks holding a higher proportion of nonagricultural loans in their portfolios and
urban banks holding a higher proportion of agricultural loans in their portfolios than their
counterparts in states with more restrictive branch banking regulations (Laderman, Schmidt and
Zimmerman; 1991).
As it was in Illinois, Chicago banks loaned disproportionately on apartment and office
buildings, while rural banks made primarily agricultural loans. Chicago banks were therefore
vulnerable to swings in the Chicago real estate market while rural banks were susceptible to local
weather disasters and swings in the price of a particular crop. Had branch banking been allowed,
Chicago banks with rural branches would have been better able to diversify into agricultural
loans, while rural banks might have merged with city banks, allowing the combinations to hold
portfolios of agricultural and urban loans that had less risk than the holdings of individual
members. Instead there was a plethora of small rural banks that were poorly diversified and ill
equipped to survive shocks to the local economy.2 The situation in Illinois and most of the rest of
the United States contrasts sharply with that of Canada, where branch banking was allowed
nationwide. In that country 18 large banks dominated the banking industry, which, unlike that of
the United States, remained stable throughout the Great Depression (White, 1984).
Although it did not allow branch banking, Illinois did permit chain or group banking,
whereby banks were affiliated through interlocking directorates, common officers, or common
stock ownership. Unlike a branch bank, the assets and liabilities of a member bank in a chain
banking system are separate from that of other members, and individual members are not
responsible for the liabilities of other banks in the chain. At least 54 of the 193 state banks in
2
A counterargument would be that branch banking might increase the number of bank failures by reducing bank
profits and retained earnings through greater competition. See for example Ramirez (2003), p. 333.
29
Chicago in June 1929 were involved in chain banking. Several contemporary authors studied the
impact of chain banking on bank failures. Thomas (1933) finds that between January 1, 1930 and
November 16, 1932 57.7 percent of all banks in Chicago went out of business while 67 percent
of the banks involved in chain banking ceased operations, but he does not conclude that the
presence of chain banking was either beneficial or harmful. Kline (1931) also concludes that
chain banks were not more likely to fail than unit banks.
Nevertheless, it is easy to see how chain banking could be unstable. If one member of a
chain bank fails, it is likely that the public, suspicious of common management, will make runs
on all the other members of the chain causing them to fail as well. However, the assistance that
other member banks in a chain can give to a distressed bank was limited because the assets and
liabilities of chain member banks were legally separate and individual members were not legally
responsible for the liabilities of other members. Moreover, Illinois state law prohibited any state
bank from making unsecured loans of more than 15 percent of its capital and surplus to any
single person or institution, including banks. Thus, for example, if twelve banks in a chain each
have one million dollars in assets and liabilities, and each bank has 80 percent of its liabilities in
deposits and 12 percent in capital and surplus (the average for Illinois banks in 1929), each bank
could lend at most $18,000 to a troubled branch ($1m x .12 x .15) for a total of $198,000. But
even this might not have been permissible as state law prohibited a state bank from loaning to
corporations controlled by officers of the bank.
In contrast, branch banking provides some stability because the assets and liabilities of all
banks in the system are pooled. Thus, there are no restrictions on aid to a troubled branch.
Indeed, because all branches are responsible for the liabilities of any one branch, assistance to
troubled branches is mandatory. It is thus easier to shift assets to troubled branches than it is to
troubled members of a chain. Thus, chain banking has the same risk of branch banking – if one
bank fails all the other members of the system are also likely to fail – without the benefit of the
pooling of assets and liabilities.
If chain banking is more unstable than branch banking, laws prohibiting branch banking
may have added another source of instability to state banking systems by encouraging
individuals that would have created branch banking systems to create chain banking systems
instead. There is some evidence that branch and chain banking systems were substitutes. For
example, in testimony before the House Committee on Banking and Currency in 1930, Roy
30
Young, a governor of the Federal Reserve Board, stated that chain banking was most prevalent in
states that did not allow branch banking (Committee on Banking and Currency, 1930, Vol. 2,
page 427).
There is also some evidence that states without legal reserve requirements and/or
prohibitions on branch banking had higher failure rates during the Great Depression. Table 6 lists
state bank regulations regarding branch banking as of June 30, 1929, as reported in the
December 1929 Federal Reserve Bulletin. States are divided into four classes; those which
prohibit branch banking, those which allowed existing banks with branches to keep their
branches but prohibited new branches, those that allowed limited branch banking, usually in the
city or county of the home branch, those that were silent on branch banking but had no branches
and those that permitted branch banking statewide. States that allowed branches statewide had an
average (unweighted) state bank failure rate of about 34 percent. States that allowed limited
branching had a nearly identical average state bank failure rate. States that either prohibited
branching by law or that were silent on branching but had no branches had an average state bank
failure rate of 40 percent.
Other studies have found mixed evidence regarding the effect of branch banking on bank
failure rates during the depression. Wheelock (1995) finds that, after controlling the extent to
which economic activity declined, the proportion of deposits in failed banks was lower in states
where branch banking was more prevalent. Mitchener (2003) finds that counties located in states
that prohibited branch banking had higher failure rates for state banks that were not members of
the Federal Reserve system. Using international data, Grossman (1994) finds that countries that
avoided banking crises during the Great Depression had substantially more branches per bank
than their counterparts in crisis countries. Ramirez (2003) finds that during the late 1920s state
banks in West Virginia were about five percent more likely to fail than their counterparts in
Virginia, a difference that he attributes to the latter’s more permissive branching regulations
since in all other aspects the two states economic, demographic and regulatory systems were
similar. However, Gambs (1977) finds that the extent of branching did not have an effect on a
state’s bank failure rate from 1922 to 1932. Calomiris and Mason (2003) find that branch banks
were more likely to fail during the depression. Carlson (2004) finds that branch banks from three
states that allowed branch banking were actually more likely to fail during the depression and to
survive for a shorter period of time. He hypothesizes that this may be because branch banks,
31
believing they were more diversified, held riskier portfolios with higher expected returns than
unit banks, making them more susceptible to systematic risk.
Population per square mile is used as a measure of the level of urbanization in a state.
Presumably states that are more urban have more diversified economies, and banks located in
these states would have more diversified loan portfolios and would hence be less likely to fail.
As can be seen in Table 6, six of the ten states with population densities of over 100 were among
the states with the 13 lowest failure rates, while only two of the 23 states with the highest failure
rates had population densities over 100. State population divided by the number of state banks is
a measure of the extent of competition among banks. All of the states with more than 10,000
residents per bank had relatively low failure rates. As another measure of diversification, I use
the share of a state’s output attributable to agriculture. Six of the 14 states with the lowest failure
rates had less than ten percent of their output in agriculture.
Unfortunately, the Bureau of Labor Statistics did not conduct its first systematic
unemployment survey until 1937. However, Wallis (1989) has made estimates of unemployment
for the early years of the Great Depression. In Table 6, I use these estimates to compare average
employment for the period 1930 to 1933 as a percentage of employment for May, 1929. As a
second measure of state economic conditions, I use per capita income in 1933 expressed as a
percent of that figure in 1929, as reported in the April, 1940 Survey of Current Business. All of
the ten states with the lowest failures rates had less of a decline in per capita income over this
period than the national average. The relationship between the decline in employment and state
bank failure rates is less clear.
One other explanation that has been offered for the relatively high failure rates for Illinois
state banks, particularly those in Chicago, was the involvement of commercial banks in
investment banking. Of the 193 state banks in Chicago in June 1929, 32 had investment banking
affiliates. Many contemporary observers blamed both the stock market crash and the collapse of
the banking system on the presence of commercial banks in investment banking. It was argued
that banks which held loans from troubled banks had an incentive to help these businesses pay
off these loans by underwriting new security issues from them of dubious quality and foisting
them on an unsuspecting public. It was also argued that the large losses that many commercial
banks suffered from their underwriting affiliates forced them out of business with a loss to
depositors.
32
Kroszner and Rajan (1994) argue that there is no evidence that conflicts of interest
induced commercial banks with investment banking affiliates to fool the public into investing in
low quality securities. Instead, investment banking affiliates underwrote securities of higher
quality because the public took possible conflicts of interest into account in making its
investment decisions. But the authors do not address the issue of whether commercial banks
involved in investment banking were more likely to fail.
The Role of the Reconstruction Finance Corporation
Another explanation that has been offered for the severity of the banking crisis in
Chicago and elsewhere and the ultimate collapse of the banking system in March 1933 is the
publication of loans made by the Reconstruction Finance Corporation (RFC). The RFC had been
created by legislation signed by Herbert Hoover on January 22, 1932, with $500 million in initial
capital and the ability to borrow up to $1.5 billion more (Olson, 1977, p. 38-39). It was
responsible for making loans to Federal Reserve member banks on assets that could not be
rediscounted with the Fed, as well as loans secured by similar assets to banks and other financial
intermediaries that were not members of the Federal Reserve System. It also provided aid to
railroads and state and local governments. Its effectiveness was limited by the fact that it took the
bank’s most liquid assets and that its loans had a short maturity date of six months at an above
market interest rate of six percent (Olson, 1977, p. 47). Mason (2001) argues that the RFC’s
reluctance to assume risk by taking lower quality assets for collateral may have worsened the
banking situation. There was no provision in the original act that such loans should be disclosed.
But in late June 1932, the Chicago banking market was on the brink of collapse when the
Central Republic Bank, one of the five largest banks in the city, was threatened by a run. To save
it, the RFC loaned the bank $90 million. This loan remains controversial. Shortly before it was
made, Melvin Traylor, a leading Chicago banker and a dark horse candidate for the Democratic
presidential nomination, had called Hoover and told him that if the Central republic Bank folded,
every other bank in Chicago would also be forced out of business, and that if the Chicago
banking market collapsed it would create a national banking crisis that would threaten every
bank in the country (Olson, 1977, p. 59). However, the president of Central Republic was
Charles Dawes, a prominent Republican who had resigned as president of the RFC eleven days
before that agency granted the bank he headed a $90 million loan. There is some evidence that
Dawes used the seriousness of he situation to increase the size of the loan (James, 1938, p. 1036-
33
1041). Although the loan allowed for the orderly liquidation of the Central Republic, it met with
criticism because it came at a time that a loan request by the city of Chicago to pay its teachers
was denied by the RFC and when small bankers were complaining that the RFC was ignoring
their needs while channeling its resources to the largest financial institutions (Olson, 1977, p.
60).3
In July, in the aftermath of the Dawes loan and the uproar that it created, the Democratic
House under the urging of Speaker John Nance Garner narrowly passed an amendment to the
Emergency Relief and Construction Act which provided that all RFC loans be made public. This
provision was opposed by all members of the RFC, Democratic as well as Republican. President
Hoover reluctantly agreed to this provision on the understanding that the RFC reports would not
be released to the press while Congress was in recess. Since Congress would not meet again until
after the election, Hoover decided that he would have time to negotiate with the Congress over
publication (Olson, 1977, p. 72). However, once the first report on RFC activities was submitted
to Congress, the clerk of the House made the report public. He released the report on August 23,
and the following day the New York Times published the names of all the banks that had
borrowed from the RFC in the last nine days of July, along with the amounts.
The RFC adamantly opposed the public disclosure of its loans. The Chairman of the
RFC, Atlee Pomerene, declared that the publication of the loans was "the most damnable and
vicious thing...ever done" (James, 1938, p. 1046). Nevertheless, the clerk of the House continued
to make the monthly reports of the RFC public. One of the directors of the RFC prepared a list
showing 62 banks, holding $70 million in deposits, had been closed by runs within 30 days of
the publication of their loans from the RFC, while another 40 banks with deposits of $42 million
closed within 60 days of publication (Myers and Newton, 1936, p. 326). In his memoirs, Herbert
Hoover states that he never would have signed the bill providing for RFC reports to Congress if
he had known that the reports would be made public. But Mason (2001) finds that banks in the
Chicago area that had a loan from the RFC disclosed were actually more likely to survive the
depression.
3
Dawes received further criticism when it was revealed in his testimony before the Senate Banking and Currency
Committee in February 1933 that almost 90 percent of Central Republic’s deposits had been loaned to the bankrupt
Insull companies, in violation of the spirit if not the letter of the Illinois state law limiting loans to a single borrower
to ten percent of a state bank’s total assets (Kennedy, 1973, p. 108). Kennedy argues that these hearings did much to
increase the public’s suspicions of the banking industry in general.
34
However, disclosure may have prevented banks from turning to the RFC for help in the
first place if banks feared that the public would respond negatively to news that it had sought a
loan. The number of applications by banks for loans from the RFC dropped continuously from its
peak in April 1932, with a particularly big drop in August, after it became apparent that loans
might be disclosed (Telser 2008). In Illinois, the number of state banks borrowing from the RFC
dropped from 14 in the final nine days of July to 34 in the entire month of August, followed by 9
banks borrowing in September and 10 in October.
Telser (2008) argues that in making the RFC loans public, thereby breaking a central
tenant of central banking, Speaker Garner brought on the final crisis that led to the shutdown of
the banking system. In January 1933, Garner, then Vice President elect, ordered that all loans
made prior to the passage of the amendment providing for disclosure be made public. This may
have been illegal. It was disclosed that the Union Guardian Trust Company, a chain of Detroit
banks, had borrowed more than $16 million from the RFC, confirming a report published in a
national magazine a month earlier. Moreover, it was leaked that the RFC had refused Union
Guardian's request for another loan. This led to a run on the bank which spread to a second chain
that had not even borrowed from the RFC. To prevent the collapse of these two chains and a
statewide panic, the governor of Michigan declared a statewide banking holiday on February 14.
The panic quickly spread to other states. On the morning of March 4, first New York and then
Chicago declared statewide moratoria, effectively shutting the nation's financial system down.
On the afternoon of March 4, President Roosevelt, in one of his first official acts, declared a
nationwide bank holiday.
Factors Unique to Chicago
There were also factors unique to Chicago that gave it the highest state bank failure rate
of any urban area in the country during the Great Depression. Prior to June, 1931, there had been
relatively few bank failures in Chicago. The city's state banks had gotten through such crises as
the stock market crash in October, 1929, the failure of the Bank of United States in December,
1930 and England's abandonment of the gold standard in September, 1931 virtually unscathed.
The collapse of the Bain group in June, 1931, the largest chain banking system in the city, was
responsible for the first great banking crisis in Chicago during the Great Depression. The
collapse of the Bain system was due largely to excessive loans on real estate, and $2 million in
uncollectible, illegal loans to John Bain and companies controlled by him. The panic spread to
35
the Foreman chain, who had also invested heavily in real estate loans. The panic subsided when
the largest bank in the Foreman chain was taken over by the First National Bank of Chicago.
However, most of the smaller banks in the chain failed. Since many of the banks that failed in the
June 1931 panic were in these two chains, it is not surprising that Thomas (1933) and Esbitt
(1986) conclude that mismanagement was primarily responsible for this panic.
The second banking crisis in Chicago was concentrated from June 20-27, 1932. It was
caused primarily by two factors. The first was the trial of John Bain which revealed the extent of
the mismanagement and fraud involved in the chain he controlled. On June 16, the Chicago
Tribune reported that the public would recover none of the $13 million that it had deposited with
the chain, and that holders of $30 million in securities sold by the group would only receive 25
cents on the dollar. On June 22 the Tribune reported that Bain had sold real estate to his banks at
several times the price at which he had purchased it. The next day it was reported that John Bain
had illegally borrowed $1.75 million from his own banks. Such sensational reports naturally
made the public suspicious of all banks.
A second factor fueling the panic was the fiscal problems of the city of Chicago. At the
end of June it had not paid its teachers, firemen or policemen for months and was preparing a
delegation including the presidents of two of the largest five banks in the city to Washington to
ask the Congress and the Reconstruction Finance Corporation for an $81.5 million loan. The
Tribune played up the story with articles about the delegation on the front page from June 19-22.
Moreover, Mayor Anton Cermak warned of dire consequences should the loan be denied. On
June 20, he was quoted on the front page of the Tribune: "Chicago is in a critical situation. If we
are forced to close up the relief stations then what will happen? I do not care to predict...[If] we
get to the point where we have to suspend the police, fire and health services, then what good
will property be?" One could imagine the reaction of the city after reading such a quote when the
loan was denied on June 22. Moreover, the Tribune reported on bank closings throughout the
week. The panic was only brought to an end by the Dawes loan on June 27.
Data Analysis
To test the importance of the financial condition of banks prior to the depression on their
chances for survival during the depression, I conduct a logit regression, with the dependent
variable set equal to one if the bank failed and zero otherwise. Banks that either went into
voluntary liquidation, paying off their depositors and ceasing operations, or were absorbed by
36
TABLE 7: FACTORS INFLUENCING BANK SURVIVAL 6/29/29-6/30/33
LOGIT ESTIMATES (DEPENDENT VARIABLE = 1 IF BANK FAILED, ELSE 0)
State Banks Outside Chicago
Constant
Reserve-deposit ratio
Log(Total Capital)
Capital to total assets
U.S. Government bonds to total assets
Other securities to total assets
Collateral security loans to total assets
Real estate loans to total assets
Banking house to total assets
Other real estate to total assets
Debt to equity
Due to banks to total assets
Time deposits to total deposits
Retained earnings to total assets
Bills payable and rediscounts to total assets
Time deposits to real estate loans
(1)
-2.76
(1.34)
-3.50***
(1.28)
0.251**
(0.109)
-1.34
(2.13)
-10.05***
(2.09)
-1.30**
(0.639)
0.204
(0.918)
-2.95***
(1.01)
9.42***
(2.56)
13.59***
(3.04)
0.080
(0.056)
-6.90
(5.53)
0.841**
(0.421)
-12.47**
(5.17)
7.63***
(1.97)
-0.011
(0.010)
Member of the St. Louis Federal Reserve
Member of the Chicago Federal Reserve
Underwriting affiliate
Loan from RFC disclosed
Number of state banks in county
37
(2)
-2.90
(1.39)
-3.49***
(1.28)
0.266**
(0.113)
-1.47
(2.18)
-10.03***
(2.11)
-1.36**
(0.640)
0.426
(0.928)
-2.99***
(1.01)
9.56***
(2.57)
13.46***
(3.06)
0.082
(0.057)
-7.23
(5.64)
0.867**
(0.422)
-12.02**
(5.20)
7.71***
(1.99)
-0.012
(0.010)
0.075
(0.606)
-0.467
(0.461)
0.987
(1.02)
-0.366
(0.252)
(3)
-2.46
(1.62)
-3.77***
(1.33)
0.243**
(0.118)
-1.43
(2.01)
-9.58***
(2.13)
-1.59**
(0.695)
-0.457
(1.06)
-3.25***
(1.07)
8.80***
(2.74)
12.39***
(3.17)
0.076
(0.056)
-7.43
(5.87)
0.712
(0.443)
-13.66***
(5.25)
7.70***
(2.03)
-0.012
(0.010)
0.513
(0.615)
-0.638
(0.477)
0.940
(1.07)
-0.427
(0.260)
0.007
(0.013)
County population per square mile
-6.64
(0.002)
1.56***
(0.428)
0.539**
(0.272)
0.673
(3.75)
-2.63*
(1.45)
0.794
(1.55)
-4.69e-09
(8.87e-09)
958
0.170
221.34
County state bank failure rate
County national bank failure rate
County unemployment rate
County retail sales in 1933 as a percent of
county retail sales in 1929
County ratio of farm debt to farm value in
1930
Average deposits of national banks in
County
Number of banks
Pseudo R-Squared
Chi-Squared
960
0.134
175.25
Chicago State Banks
960
0.137
179.10
(1)
Constant
8.51
(6.98)
-6.90
(5.62)
0.155
(0.387)
-12.62
(9.57)
-11.43*
(6.83)
-5.41
(3.65)
-6.75*
(3.79)
-2.98
(5.32)
12.21
(12.59)
131.11**
(65.07)
-0.328
(0.231)
-31.85*
(18.73)
2.85
(2.46)
-139.40***
Reserve-deposit ratio
Log(Total Capital)
Capital to total assets
U.S. Government bonds to total assets
Other securities to total assets
Collateral security loans to total assets
Real estate loans to total assets
Banking house to total assets
Other real estate to total assets
Debt to equity
Due to banks to total assets
Time deposits to total deposits
Retained earnings to total assets
38
(2)
13.08
(8.23)
-7.00
(6.41)
-0.458
(0.528)
-8.26
(9.85)
-7.73
(7.63)
-3.83
(3.68)
-5.50
(3.74)
-4.40
(5.35)
10.92
(13.55)
153.65**
(67.22)
-0.204
(0.235)
-27.04
(22.07)
4.79
(3.00)
-143.66***
(39.35)
34.22*
(19.72)
-0.029
(0.044)
Number of banks
147
(43.51)
32.23
(21.01)
-0.068
(.054)
-0.676
(1.08)
1.25
(0.777)
2.03*
(1.14)
-0.835
(0.817)
147
Pseudo R-Squared
0.404
0.465
Chi-Squared
66.95
77.08
Bills payable and rediscounts to total assets
Time deposits to real estate loans
Member of the Chicago Federal Reserve
Member of a banking chain
Underwriting affiliate
Loan from the RFC disclosed
Standard errors in parenthesis
*Significant at 10%
**Significant at 5%
***Significant at 1%
other banks neither failed in the sense that they could not repay their depositors nor survived
until the end of the period.4 Hence they are excluded from the regression. Banks that were
absorbed by other banks after June 1929 are also excluded from the regression. I run logit
separately for state banks in Chicago and outside of Chicago. The results are shown in Table 7.
In the first model (column 1), the independent variables are various financial ratios as of
June 29, 1929. For both classes of banks, banks with relatively more retained earnings were
found to have a lower likelihood of failure. For state banks outside of Chicago, larger banks with
more capital were actually found to be more likely to fail, indicating that size was not an
advantage outside of Chicago. However, as would be expected, banks that had relatively more
liquid portfolios, including a larger ratio of reserves to deposits and relatively more secure assets
such as U.S. government bonds were found to be at a lower likelihood of failure. On the other
hand, banks that before the depression relied more on time deposits or on borrowed funds such
as bills payable and rediscounts, which tend to be more costly, or that held more foreclosed real
estate property or invested more in their own place of business were found to be more likely to
4
Illinois regulations regarding state banks that wished to undergo voluntary liquidation were very strict. Such banks
were required to deposit with the state auditor in advance an amount equal to all of its outstanding deposits and other
debts, including the auditor’s fees. Likewise, any state bank absorbing another state bank was required to assume all
the debts of the bank that it acquired (Illinois Auditor of Public Accounts, Banking Law of the State of Illinois 1933,
p. 9).
39
fail. State banks outside of Chicago that had relatively more real estate loans were actually found
to have a lower likelihood of failure, indicating that, to the extent it existed, concentration in real
estate loans only hurt bank stability in Chicago. For Chicago, state banks which before the
depression held relatively more other real estate, which tended to be land and fixtures
repossessed by banks as a result of default, were found to have a higher likelihood of failure
during the depression. On the other hand, Chicago state banks which held more of the deposits of
other banks were relatively less likely to fail, indicating that bankers themselves had a good idea
ex ante which banks were at greater risk.
The second model (column 2) in Table 7 shows the results when the independent
variables are expanded to include certain other individual characteristics of banks, such as
whether they belonged to the Federal Reserve Bank of Chicago, had an underwriting affiliate, or
had a loan disclosed by the Reconstruction Finance Corporation. In all five cases, dummy
variables were used. In each of the first three cases, the dummy variable was set equal to one if
the bank was a member of the Federal Reserve Bank off St. Louis, was a member of the Federal
Reserve Bank of Chicago, or had an underwriting affiliate, and zero otherwise. In the case of
RFC publicity, the dummy was set equal to one if a bank that had not already failed had a loan
from the RFC disclosed and zero otherwise. For state banks in Chicago, a dummy variable was
set equal to one if the bank was identifies by Kline (1931) as being a member of a chain and zero
otherwise. For state banks outside of Chicago, the same results hold as in the first logit
regression; none of the bank-specific factors added in the second column are found to be a
predictor of bank failure. However, Chicago state banks that were members of a chain or which
had an underwriting affiliate were found to be more likely to fail
In the third model (column 3), for state banks outside of Chicago, I add in characteristics
of the county in which the bank is located. These include the county’s population per square
mile, a measure of the level of urbanization and hence diversity of the county; the number of
other banks in the county, a measure of the degree of competition; the failure rate for all the
other state banks in the county, and the failure rate for all national banks in the county. To
measure the impact of the burden of farm debt on borrowers, which may affect their ability to
repay this debt, I include the ratio of farm debt to farm value for the county in 1930. To measure
the impact of competition from national banks, I include the average deposits of national banks
40
in the county in 1929 (Federal Deposit Insurance Corporation, 1929) . To control for local
economic conditions I also include the county unemployment rate in 1933 and retail sales in the
county in 1933 as a percent of retail sales in the county in 1929.5 Banks in counties which saw
retail sales fall by less between 1929 and 1933 were less likely to fail. Perhaps the most
interesting result is that, even controlling for local economic conditions and other countywide
factors, the county failure rate was found to have a highly detrimental effect on the probability
that a bank would survive the Great Depression. Regardless of a bank’s financial position, if it
was located in a county where a lot of other banks were failing, it was more likely to fail itself.
The county failure rate was positive for both state and national banks, but the coefficient for state
banks was three times higher than the coefficient for national banks. Figure 11 shows state bank
failure rates for the 102 counties in Illinois. There appears to be little regional correlation among
bank failure rates. The four counties with the worst failure rates (over 75 percent), for example,
are scattered throughout the state and are not adjacent to each other. The thirteen counties with
the next highest failure rates (60 to 75 percent) are also scattered throughout the state, and in
only two cases are they adjacent to each other.
Logit does fairly well in predicting bank failures during the Great Depression. For state
banks outside of Chicago, model 1, which only employs financial statement data from June
1929, predicts a fifty percent or higher probability of failure for 214 of the 403 banks that failed
(53 percent). It predicts a probability of failure of less than fifty percent for 451 of the 557 state
banks outside of Chicago that survived (81 percent). Thus, about 69 percent of all Illinois state
banks outside of Chicago were correctly classified under model 1. Model 1 falsely predicts
failure for 106 banks that survived and falsely predicts survival for 189 banks that failed. Model
2, which considers other bank characteristics such as membership in the Federal Reserve, the
presence of an underwriting affiliate or the disclosure of an RFC loan, and Model 3, which
considers characteristics of the county in which the bank is located, have results that are nearly
5
I am grateful to Price Fishback for providing me with this data.
41
FIGURE 11: ILLINOIS STATE BANK FAILURE RATES BY COUNTY, 6/29-6/33
42
identical to model 1. For state banks in Chicago, model 1 predicts a fifty percent or higher
probability of failure for 103 of the 110 banks that failed (94 percent), while predicting a less
than 50 percent probability of failure for 14 of the 37 banks that survived (38 percent), thus
correctly classifying about 86 percent of all Chicago state banks. Once again Model 2, which
considers other characteristics of Chicago state banks such as membership in the Federal
Reserve, the presence of an underwriting affiliate, the disclosure of an RFC loan, or membership
in a chain, has results that are nearly identical to Model 1.
One problem with logit analysis is that it treats all bank failures equally. We would
expect banks that failed relatively early during the depression to have been in weaker condition
than banks that failed later. For state banks outside of Chicago, there are 412 failures out of
1,234,181 days in operation, giving an incidence rate of .000334. The Kaplan-Meier survivor
function estimates about a 25 percent chance of a state bank outside of Chicago failing by the
middle of 1932. For state banks in Chicago, the incidence rate was about twice as high, with 120
failures out of 177,877 days in operation, for an incidence rate of .000675. The two nearly
vertical drops in the survivor function for Chicago represent the panics of June 1931 and June
1932, which had a negligible effect on state banks outside of the city. Chicago state banks had
about a 25 percent chance by mid 1931 and a fifty percent chance of failing by mid 1932. Not
surprisingly, a log-rank test for the equality of survivor functions finds that Chicago state banks
were at a higher risk of failure.
I perform further survival analysis by employing a Cox proportional hazard model. State
banks in Chicago and outside of the city are analyzed separately. The results are presented in
Table 8, while Figure 12 presents a Kaplan-Meier survival curve. The Cox proportional hazard
model results are similar to those derived from the logit model. For state banks outside of
Chicago, banks that had higher reserve deposit ratios, more government bonds or other securities
in their portfolios, or greater retained earnings before the depression had a lower hazard of
failure. Conversely, larger banks and banks that relied more on bills payable for financing before
the depression had a higher hazard of failure. After controlling for such factors as financial
condition before the depression, other bank characteristics, and local economic condition, banks
in counties with higher state bank failure rates were found to have a higher hazard of failure. For
Chicago state banks, banks that held more of the deposits of other banks were at a lower hazard
of failure, which might indicate that
43
TABLE 8: FACTORS INFLUENCING BANK SURVIVAL 6/29/29-6/30/33
HAZARD RATIOS USING THE COX PROPORTIONAL HAZARD MODEL
State Banks Outside Chicago
Reserve-deposit ratio
Log(Total Capital)
Capital to total assets
U.S. Government bonds to total assets
Other securities to total assets
Collateral security loans to total assets
Real estate loans to total assets
Banking house to total assets
Other real estate to total assets
Debt to equity
Due to banks to total assets
Time deposits to total deposits
Retained earnings to total assets
Bills payable and rediscounts to total assets
Time deposits to real estate loans
(1)
0.0307***
(.030)
1.16**
(0.086)
0.166
(0.309)
1.16e-04***
(1.98e-04)
0.244***
(0.121)
1.19
(0.768)
0.129***
(0.093)
1245.34***
(1964.36)
3023.70***
(5069.45)
1.045
(0.046)
.0057
(0.026)
1.830**
(0.557)
1.19e-05***
(4.87e-05)
185.09***
(196.72)
0.994
(0.0077)
Member of the St. Louis Federal Reserve
Member of the Chicago Federal Reserve
Underwriting affiliate
Loan from RFC disclosed
Number of banks in county
County population per square mile
44
(2)
0.0308***
(0.0299)
1.18**
(0.090)
0.123
(0.237)
9.94e-05***
(1.71e-04)
0.237***
(0.117)
1.679
(1.088)
0.133***
(0.095)
1850.4***
(2918.4)
2734.28***
(4562.3)
1.05
(0.047)
0.0049
(0.022)
1.888**
(0.577)
1.88e-05***
(7.77e-05)
202.05***
(213.10)
0.994
(0.008)
1.042
(0.442)
0.750
(0.262)
2.44*
(1.32)
0.555***
(0.102)
(3)
0.017***
(0.017)
1.20**
(0.094)
0.213
(0.373)
1.59e-04***
(2.7e-04)
.220***
(0.114)
0.746
(0.530)
0.114***
(0.083)
497.05***
(765.77)
1467.92***
(2485.63)
1.04
(0.044)
0.0014
(0.0067)
1.609
(0.497)
4.39e-06***
(1.79e-05)
292.77***
(314.30)
0.994
(0.008)
1.596
(0.689)
0.634
(0.224)
2.02
(1.10)
0.522***
(0.097)
1.005
(0.0087)
1.000
(0.0006)
County failure rate for state banks
2.878***
(0.855)
1.625***
(0.292)
10.88
(26.95)
0.127**
(0.131)
0.702
(0.752)
1.000
(4.42e-08)
958
268.54
County failure rate for national banks
County unemployment rate
County retail sales in 1933 as a percent of
county retail sales in 1929
County ratio of farm debt to farm value in
1930
Average deposits of national banks in
County
Number of banks
Chi-Squared
Chicago State Banks
960
203.60
Reserve-deposit ratio
Log(Total Capital)
Capital to total assets
U.S. Government bonds to total assets
Other securities to total assets
Collateral security loans to total assets
Real estate loans to total assets
Banking house to total assets
Other real estate to total assets
Debt to equity
Due to banks to total assets
Time deposits to total deposits
Retained earnings to total assets
Bills payable and rediscounts to total assets
Time deposits to real estate loans
Member of the Chicago Federal Reserve
45
960
217.15
(1)
(2)
0.010
(0.250)
1.12
(0.164)
0.009
(0.027)
5.24e-04**
(1.81e-03)
0.044**
(0.054)
0.007***
(0.011)
0.211
(0.411)
0.253
(0.785)
2.27e+10**
(2.32e+11)
0.886
(0.075)
7.50e-08*
(7.21e-07)
7.06*
(7.54)
1.05e-29***
(1.47e-28)
57481.23**
(290787.2)
0.991
(0.024)
0.038
(0.108)
1.019
(0.178)
0.005*
(0.014)
0.026
(0.093)
0.041**
(0.050)
0.007***
(0.010)
0.198
(0.403)
0.194
(0.620)
7.20e+10**
(7.68e+11)
0.858*
(0.077)
2.51e-07
(2.66e-06)
9.19**
(9.89)
9.54e-26***
(1.34e-24)
102114**
(519423)
0.986
(0.026)
0.620
147
(0.283)
1.49*
0.342
1.601
(0.572)
0.303**
(0.141)
147
86.26
100.32
Member of a banking chain
Underwriting affiliate
Loan from the RFC disclosed
Number of banks
Chi-Squared
Standard errors in parenthesis
*Significant at 10%
**Significant at 5%
***Significant at 1%
0.00
0.25
0.50
0.75
1.00
FIGURE 12: KAPLAN-MEIER SURVIVAL ESTIMATES
0
500
1000
1500
analysis time
State banks outside of Chicago
Chicago state banks
bankers had a good idea of which banks were riskier than others. As in the logit model, Chicago
state banks that had more other real estate in their portfolios were at a higher hazard of failure
while those with relatively higher retained earnings were at a lower hazard of failure. The only
major difference from logit is that under the Cox proportional hazard model state banks that had
46
a loan from the RFC disclosed were found to be at a lower hazard of failure, probably because
they had survived at least until mid-1932.
The evidence from this study suggests that bank failures during the Great Depression
were different from those that had occurred previously. During the 1920s, failures were due
primarily to bank-specific factors, such as high reliance on borrowed funds or low retained
earnings. Despite the high number of bank failures during the 1920s by the historical standards
of the time, there is no evidence the situation in the county that the bank was located in played a
major role in bank failures. However, this is not true for bank failures during the Great
Depression. While it is true that firm-specific factors continued to play a role, the bank’s location
was also an important factor, as evidenced by the statistically significant higher likelihood of
failure for banks located in counties with high failure rates, regardless of financial condition.
Whether the importance of bank location in bank success or failure during the depression was
due to contagion or other factors is an open question.
Another interesting question remaining is why the Chicago banks did so poorly, both
with respect to banks in the rest of the nation and the rest of Illinois. Most of these failures
occurred in three months; June 1931 and June and July 1932; and appeared to have been
unrelated to banking events in the rest of the country. New York City, the nation’s major
financial center, did much better. One major difference between the two centers was that branch
banking was allowed in New York City while it was not allowed in Chicago. Another difference
might be in the practices of the Federal Reserve Banks of New York and Chicago. At the time,
the individual Federal Reserve Banks were largely autonomous, setting discount rates in their
own districts, subject to the almost automatic approval of the Federal Reserve Board, and
conducting open market operations on their own accounts. It is interesting to note that the head
of the Chicago Fed, James B. McDougal, was one of the most conservative members of the
Federal Reserve Board, while George Harrison, head of the New York Fed, was the leading
advocate of an expansionary monetary policy. It would be useful to compare the balance sheets
of New York and Chicago banks to determine if there was a difference in the financial condition
of the banks of these two cities, or if other factors were involved.
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