Monday, May 31, 2010

Oh, no! Not the Dreyfus Affair Again!

This blog is supposed to be devoted to issues related to the Great Depression and people making use of parallels between our current affairs and the Depression. I set out to do this because I've done lots of research into the Depression and actually know something about it. But the Depression is not the only thing I've done research into and know something about. I used to be a historian of modern France and for many years did my research in libraries and archives in France. The Depression isn't the only subject abused lately by people who don't know very much about it. Another topic that too often crops up as a metaphor for contemporary events and, thus, continues to attract crowds of commentators who know little about it is the Dreyfus Affair.

I saw a prime example when my brother sent me a review of Louis Begley's "Why the Dreyfus Affair Matters" printed in the New Yorker last fall. The review was by a writer named Adam Gopnik, about whom I know nothing. I have not and do not plan to read the book by Begley, who is evidently a novelist and lawyer greatly exercised by the prisoners at Guantanamo. We may very well share similar views about the prison at Guantanamo and the rights of its prisoners, but I doubt we would agree much about the Dreyfus Affair.

I don't know if Gopnik is getting his misinformation about France and the Dreyfus Affair from Begley's book, but before running such a review somebody at the New Yorker should have done a bit of fact checking. I'll start with Gopnik's assertion that after the defeat at the hands of the Germans in 1871 the French Republic changed its laws to make officer recruitment and promotions more meritocratic, democratic and less aristocratic. In fact it was exactly the opposite: the lesson that the Republicans drew from their defeat was the method of promotions from the ranks introduced by Napoleon I during his Empire and retained by French kings afterward guaranteed an army of amateurs led by poorly educated peasants. Exhibit A in this argument was General Francois Bazaine, whose gross incompetence (and supposed treachery) cost France here mightiest fortress at Metz and surrendered an entire French army into German imprisonment. The French resolved to build a professional officer corps--modeled after the Prussians'--from "the very best" French schools had to offer. This meant that officer candidates were drawn not from the ranks educated in village elementary schools across France, but from a small number of elite and expensive--mostly Catholic--institutions favored by the aristocracy and upper bourgeoisie. As the reforms took hold the profile of French officers assumed an increasingly aristocratic and Catholic profile. See: Raoul Girdardet, La Société militaire de 1815 à nos jour (Plon, Paris, 1953) who explains it all.

Gopnik is right on several points: the persistence of Mathieu Dreyfus, brother of the wrongly convicted Captain Alfred Dreyfus, kept the Dreyfus case alive and in the public realm and thus deserves credit for his brother's ultimate vindication; Senator Auguste Schereur-Kestner was an early selfless advocate for Dreyfus who jeopardized his career by championing his cause; Colonel Georges Picquart also endangered his career and his life by repeatedly pushing to have Dreyfus's case reopened. However, the rest of the Dreyfusard gang are rather less saintly and most often jumped on the Dreyfus bandwagon to further their own careers or pet causes that had little to do with the innocent captain languishing on Devil's Island.

When Gopnik writes, "At last, the appeals worked their way to the top of the French courts, and a second Dreyfus court-martial was ordered," he betrays a lack of familiarity with the story. Captain Dreyfus's wife, Lucie, submitted a petition of appeal to the Army immediately upon his conviction in 1894 and it was rejected, leaving a presidential pardon as the only recourse. It was denied. This legal dead end for the Dreyfus family meant that the only way to get Alfred out of prison was to get the laws changed and that meant political action. Thus, the family chose to pursue a political path because there was no judicial path open to them. The resulting politics chaos is what made it an "Affair."

Gopnik then claims "the fix was in" for Dreyfus's second trial--ordered by Prime Minister Rene Waldeck-Rousseau to put an end to agitation in the streets stirred up by the two sides in the Affair. He is repeating the assertion that would have landed Emile Zola in jail in 1898 if he hadn't fled to England after his conviction for libel for unsupportable assertions in his famous article "J'Accuse." Zola had falsely claimed that Dreyfus's judges in his first trial in 1894 were just following orders when they convicted him. Of course they were not, nor were the judges in Rennes who found Dreyfus guilty in his retrial in 1899. They found Dreyfus guilty because they were incompetent judges, not because they had been ordered to.

Throughout Gopnik insists that the Dreyfus Affair pitted "the good guys" on the left against "the bad guys" on the right. That simplistic scheme doesn't work on any level. Many on the left were vehement anti-Dreyfusards, while the politicians who decided to finally end the Affair and saw to its conclusion were no one's idea of leftists: prime Minister Rene Waldeck-Rousseau made his legal career as lawyer for the Comite des Forges--roughly the equivalent to being the head lobbyist for the National Association of Manufacturers. He could get along with French socialists only because he was no friend of the Catholic Church nor of aristocrats who still dominated "society." The other politician whose conversion to the Dreyfus cause allowed for the revision of the case was Raymond Poincare, who pretty much defined the center of French politics--neither left nor right. Without Poincare and his fellow centrists revision would have been impossible.

But more importantly, "the good guys" were not devoted to justice and rule of law any more than their anti-Dreyfusard opponents. They were happy to see anti- Dreyfusard in chief, Paul Deroulede, dragged into a kangaroo court on trumped up charges of conspiracy and railroaded into exile. Best of all, the prosecution even used a document that had been tampered with by the police to buttress their case. How Paris Police Prefect Louis Lepine was any more of a "good guy" than "bad guy" forger Hubert Henry is hard to see. But people have been seeing things in the Dreyfus Affair that aren't there for over a century now.

Saturday, April 24, 2010

Bloomberg News v. the Federal Reserve Bank

The New York Times announced on March 19 2010 that the Federal Appeals Court has found in favor of Bloomberg News and Fox News that sought release of the names of banks that received emergency loans from the Federal Reserve Bank in 2008. The Fed had objected on the grounds that releasing such sensitive information would jeopardize the institutions that had taken the loans, thus putting the loans at risk as well. That seems like a reasonable argument, but is it?

We've faced this situation before: in 1932 and 1933 Congress demanded a list of banks and other institutions that had received loans from the Reconstruction Finance Corporation (RFC.) The RFC and banks fought the demand by arguing that the release of such sensitive information would put the borrowers, and hence the RFC, at risk if the public became alarmed at the news. Nevertheless, the lists were duly released starting in August 1932. In February 1933 the RFC handed over to Congress retroactive lists of banks that had received loans before July 1932. The bank panic of March 1933 followed and many in the industry--and sympathetic to the RFC--claimed that the panic was a direct result of the release of the lists, and that hundreds of banks failed because of the adverse publicity. That was nonsense. There was no direct or even indirect connection between the release of the lists and the March bank panic, and the failure of very few banks could be plausibly blamed on the RFC publicity.

How do we know? Because we still have the lists and the Comptroller of the Currency thoughtfully provided us with lists and much useful information about failed national banks. Comparable information about state-chartered banks unfortunately does not exist. Nevertheless we can use the information to draw judgements about national banks that received loans, had that information released, and subsequently failed.

Number of nat. banks that received RFC loans July 1932-Feb. 1933: 572
Number of those banks that subsequently failed: 32

Only six percent of the national banks whose loans were revealed on the lists were forced to close. The argument at the time was that such banks would be subjected to runs by depositors seeking to withdraw their monies from banks revealed to have problems enough to require loans from the RFC. Of the 32 banks that failed, six actually experienced an increase in their deposits between their last examination and their failure. Seven more saw their deposits drop by five percent or less, that is to say nothing dramatic. The worst cases (there were two) saw deposits drop by 36 percent. Even if we assume that the 19 banks that saw their deposits drop were fatally undermined by the RFC publicity--which is far from certain--that suggests that 13 out of 572 banks were subjected to bank-killing withdrawals by nervous depositors. Of course, that is bad news for those 13 banks, but asserting that two percent of banks with RFC loans failed because of the adverse publicity is a pretty weak argument against the publication of the information.

The worst news about the failed banks is that five of them would have been considered moderately big at the time: they each held deposits worth more than $5 million. Today that would be a tiny bank, but in 1933 it was not. Together they held c. $44 million in deposits, which at the time was a substantial amount of money. $13 million of those deposits belonged to people in Atlantic City, N.J., so certainly they had good cause to complain about the RFC publicity. With apologies to Atlantic City residents, it's hard to conclude that the loan publicity did much real harm.

Perhaps the right question to ask is: what good did the publicity do? The RFC would almost certainly have been reauthorized in July 1932 without the publicity clause. But a string of articles by progressive journalists ill-disposed toward banks had made it hard for congressmen to resist including the publicity clause. A massive $90 million loan to a Chicago bank directed by ex-U.S. Vice President Charles Dawes, and also ex-President of the RFC, soured many Americans on the RFC loan program. That was the real problem in 1932. The publicity served no good financial purpose. It did serve a political purpose: it showed that the vast majority of loans went to small or very small banks in little towns all across America. Faith in the RFC was sufficiently restored that it carried on its mission for the rest of the Roosevelt administration through the Second World War. That was not a bad thing.

I'm not sure what good purpose publicity would serve today. It might just make the political process of future loans more problematic. Maybe that would be a good thing.

Thursday, April 15, 2010

Resolution Corporation a la 1933

When Felix Salmon and Peter Wallison debated the newly proposed "Resolution Corporation" on the PBS New Hour last night neither drew any parallels with the national experience in the 1930s, but they easily could have, for we have been here before--sort of.

In 1932-33 Virginia Senator Carter Glass (of Glass-Steagall) pushed mightily for the federal incorporation of a "Liquidation Corporation" to assume the assets of failed banks for orderly disposal. Glass argued that liquidation over a period of years rather than months would prevent sluggish markets from being inundated with unwanted (and weak) assets that might raise only pennies on the dollar. A slower liquidation would raise more money and in the mean time some assets, like railroad bonds, might fetch their full value rather than some hefty discount.

Glass's idea never came to fruition because others in Congress argued that the federal government had already created the Reconstruction Finance Corporation (RFC) that could perform the same function. In fact, it did.

Felix Salmon argued on the News Hour that "No one is going to lend to a bankrupt bank. Banks have to be liquidated. They can't operate in bankruptcy." Oh, no? The RFC loaned hundreds of millions of dollars to banks in receivership in the 1930s, and it made perfect sense to do so for the very reasons that Sen. Glass wanted the Liquidation Corp. The RFC loans allowed banks to pay off creditors (depositors), which presumably would be the purpose of the Resolution Corp., and sell off assets over time. Various states (like Iowa and Montana) also passed laws allowing banks in receivership to continue operating on their "good assets" even while their affairs were being unwound. That, too, was a sound policy that worked pretty well.

Peter Wallison's principal objection to the Resolution Corp. was that it will only be used to pay off the creditors of the biggest non-bank institutions. Banks are already covered by FDIC, so the Resolution Corp. is intended only for non-bank institutions and only for those companies that are "too big to fail." This would be untrod territory. The RFC loaned money to railroads, insurance companies, and mortgage and agricultural credit companies, but it never loaned any money to private banks (which served the purpose of today's investment banks) or any other underwriting corporation. So the very entities that would presumably be the target of today's Resolution Corp. never received a dime in the 1930s from the RFC.

The fact that Wall St. firms like J.P. Morgan and Kuhn, Loeb received money as creditors of companies that received RFC loans, (i.e., railroads used RFC loans to pay back loans from Morgan) caused a storm on Capitol Hill that nearly sank the RFC that required Congressional reauthorization. The animus among politicians was so strong that such entities would never have directly benefited from the largess of the Treasury. The proposal to do so today is in dramatic contrast to the 1930s.

Wednesday, April 14, 2010

Paul Krugman is almost right!

I don't often agree with Paul Krugman, but sometimes I do. In his April 2 offering he briefly lays out his ideas on financial regulation reform. I agree with him as far as he goes. But as this blog is dedicated to clearing up misunderstandings about events of the 1930s, I'll stick to his assertion about the disastrous impact of small-bank failures during the Great Depression.

The problem with Krugman's assertion is there is no real evidence to back it up. In 1983 then Professor Ben Bernanke published an influential and oft-cited article about the impact of bank failures on the availability of credit. In it he argues that numerous pressures on banks, including loan defaults, fears of bank runs, and disappearing small banks staffed by knowledgeable experts, all combined to raise "the real costs of credit intermediation" or make the credit markets less effective and efficient at provisioning credit in the 1930s. But Bernanke argues that a host of issues combined to cause these problems, not just the collapse of small banks.

Had the system been faced simply with the slow elimination of small banks, then the 1930s would have looked a lot like the 1920s, when small banks failed by the thousands. There is no particular reason to think that the continued disappearance of small, mostly rural banks had a greater impact in the 1930s and I've seen no research to suggest that it did. The elimination of nearly 5,879 banks had no noticeable impact on the economy of the country during the 1920s. The worst year in the 1920s was 1926 when 976 small banks failed, freezing $260 million. The worst year for banks during the Depression was 1931 when 2,293 banks failed freezing $1.69 billion. Many of those banks were sizable national banks and trust companies in major cities like Boston, Philadelphia, Chicago, and Pittsburgh. When those banks collapsed they sent shock waves reverberating through the economic system.

The failure of larger banks in mid-sized towns and cities had a decided impact by freezing the deposits of many 1,000s--sometimes hundreds of thousands--of citizens and businesses, big and small. Locked out of their accounts--often for years--many small businesses succumbed to the dreadful conditions they faced during the Depression. Often the businesses forceably separated from their deposits were other banks, all of which maintained accounts in correspondent institutions. The failures of the larger institutions sent shock waves rippling through the economy while hundreds of millions of dollars remained locked away and unavailable.

The collapse of small banks did not produce those kinds of strains and most often affected only small local markets. That was always bad news for those mostly rural areas, but had little to no adverse impact on the nation.

Tuesday, April 13, 2010

About Glass-Steagall

As the financial crisis unfolded in 2007 though 2009 I spent many frustrating hours in front of my t.v. and reading newspapers receiving the explanations provided by America's experts on the financial system and economy. I was forced to take their word for it when they explained the workings and problems of our current system, but as a historian of the Great Depression I was--and am--in a position to evaluate their understanding of our past. For the most part they little understood what happened in the American financial crisis of the early 1930s. What I'd like to do is clear up some misconceptions about what happened during the Great Depression.

The David Leonhardt article on financial reform in the New York Times Sunday Magazine on March 22 of this year provides a good example of a well done piece by a leading journalist meant to explain complex problems. I've read Leonhardt's works closely and appreciatively for the past several years and overall I admire his knowledge and ability to explain. But he is, after all, a journalist and not a historian of the 1930s, so he repeats accepted orthodoxy about the era and continues to recycle misunderstandings or mistakes written into the literature. Leonhardt does not know how the banking system worked before the Glass-Steagall Act of 1933 (there was a previous Act in 1932 that changed the backing for the dollar), nor does he understand what the Act did.

Leonhardt writes that after Glass-Steagall banks could no longer use deposits to speculate on the stock market. Before 1933 the only kind of banks that could do that were the private banks like J.P. Morgan and Co., or Kuhn, Loeb, and Co. No nationally chartered bank (any bank with "national" in its title, like Chase National Bank) could legally invest deposits in corporate stocks. There were a few exceptions for some state-chartered banks, rules varied from state to state, but overwhelmingly banks in states that permitted them to buy stocks (like S.C.) did not do so because it was universally considered "bad banking practice," and avoided even by bankers of dubious repute. Banks were allowed to hold corporate securities that had been claimed as collateral for bad loans--just like they were allowed to hold real estate in the same circumstances--but only until they could dispose of it.

When Leonhardt asserts that forbidding banks that accepted deposits, which is what makes a bank a bank, from also underwriting stocks "shored up the two sides of the bank's business--its relationship with savers and borrowers--and reduced the odds that a bank would go under," he is simply restating orthodoxy, so I can't blame him too much for being so wrong. But wrong he certainly is. There is no evidence that any depositor in the U.S. lost a dime in the 1930s because their deposits were invested in the tumbling stock markets. As the only banks whose deposits were affected by Glass-Steagall were the big private banks like Morgan, and those banks were in no danger at all of collapsing, it is difficult to see how this provision saved any depositors or any banks. It did neither.

What Virginia Senator Carter Glass wanted to do in his bill was prevent banks from loaning money to brokerage firms (called brokers' loans) and from accepting stock as collateral for any loans from anybody. He was deluged with letters from bankers assuring him that this would cripple not only the stock exchanges, effectively cutting them off form any credit, but seriously cripple commercial banks which routinely accepted stock as collateral for loans to businesses. All businesses would have a much harder time borrowing money, which would have been especially devastating in the dark days of 1931 and 1932, when Glass was crafting his bill. So his compromise was to separate the corporate boards of banks from the boards of securities underwriting or dealing entities. No one who sat on a bank board or served as an officer could also sit on a board or serve as an officer of a securities-dealing firm. Thus, Chase Securities Corp. was separated from Chase National Bank, and it could no longer maintain a sales desk in the lobby of any Chase Bank as it had before 1933 (in fact the two separated before Glass-Steagall.)
This compromise by Glass had little real impact on the operations of either banks or securities-dealing companies, and there is little evidence that it did anything either to shore up banking or make securities dealing any safer. Banks and securities dealers were entirely willing to accept this "reform" because it made so little difference. Don't take my word for it, read Eugene Nelson White's article on the question.

Having dodged the nearly fatal bullet of outlawing brokers' loans, all involved--stock brokers, banks, and politicians--were delighted to celebrate the ineffectual and inconsequential separation of corporate boards as a reform of historic dimensions that saved us from future calamities. It has been thus celebrated ever since.

Perhaps my final observation about Glass-Steagall is petty-fogging, but it grates on me to see FDR get credit where he doesn't deserve it. Glass-Steagall Act of 1933 was entirely written and debated months before FDR took office in March 1933. Both houses of Congress had passed their respective versions--Glass's contained a grab-bag of bank reforms such as baring interest-bearing checking accounts; Steagall's version was devoted to a federal guarantee of deposits--but they had yet to reconcile the two bills. They could have done this during the second session of the 72nd Congress (Dec. 1932-Mar. 1933), but Democrats in both Houses were following FDR's orders not to pass any major reforms--including bank reform--until he assumed the presidency. When the bill finally arrived on his desk in June 1933, FDR still believed deposit insurance a bad idea that could cripple sound banks, but seeing which way the wind--or gale--was blowing he signed it anyway. Glass-Steagall was not in any way "Roosevelt's bank reforms." FDR's hesitancy, even reluctance, to sign the bill once it landed on his desk has never prevented him from taking full credit for it.

Sunday, April 11, 2010

Even Ben Bernanke is Sometimes Right

I reserve the right to be picky-picky-picky with Ben Bernanke because, for one, he's Chairman of the Federal Reserve Board and--more importantly--as journalists never tire of reminding us, he made his reputation as an expert on the Great Depression. So, Bernanke's views on the Depression deserve especially close scrutiny. In a recent address at the Center for the Study of the Presidency and the Congress, Bernanke made numerous assertions about the Depression that require closer examination.

Comparing actions by the Executive branch and the Fed during the 1930s and today, Bernanke claimed that the recent "stress tests" of financial institutions paralleled the evaluation of banks nationwide during the bank holiday of March 1933. Good lord, I hope not! Those "examinations" consisted at their most rigorous as a quick perusal of the latest periodic reports by state and federal bank examiners over a long weekend. That is, most bank examiners--with the assistance of Treasury and Fed staff and in most states with the help of internal auditors supplied by the biggest banks and trust companies--reviewed reports already submitted by examiners in January 1933. In many cases, banks didn't even get that close an inspection: big bankers, like Joseph Wayne of the Philadelphia National Bank, sat down with Fed governors, like George Norris in Philadelphia, and drew up lists of banks they figured were probably sound. Fed Chief Counsel Walter Wyatt later mused in a letter to Under Secretary of the Treasury Arthur Ballantine, "What would it have done to public confidence if we had published the formula finally adopted for determining which were sound banks there were to be permitted to reopen?" We can only hope that the "stress tests" were more reliable. I doubt they were.

Bernanke went on to roundly criticize then Treasury Secretary Andrew Mellon for recommending that debts needed to be liquidated, presumably through the courts and bankruptcy. Bernanke is only repeated orthodoxy in chastising Mellon for his ruthless heartlessness. But was Mellon wrong? The record of the next ten years (Mellon resigned in Feb. 1932) provides no powerful evidence to refute his insistence that piling more debt, via the RFC and other government programs, on top of existing bad debts was only compounding problems and delaying recovery. Many agreed with Mellon that clearing up the tangle of debts, especially European War debts to the United States, would have been the most effective road out of the Depression. I don't know that Mellon was right, but it is far from obvious to me that he was wrong.

When Bernanke argued the importance of cooperation of central bankers from the major financial powers, he was certainly right. More cooperation among bankers and statesmen from 1930 through 1933, when FDR sabotaged international talks underway in London to coordinate actions among the major nations, would have certainly helped the U.S. emerge from the Depression long before it did.

He finally compared the gush of money out of Wall St. hedge funds in 2008 to the bank runs of the 1930s. Hmmmm...I guess so, but it's a stretch. It's certainly true that in the early 1930s some depositors lost faith in some banks and yanked out their money, but the parallel here would be when large depositors, like Standard Oil of Ohio, lost confidence in reckless banks, like the National Bank of Kentucky, and withdrew their deposits. That was repeated many times and often by big banks that lost confidence in other banks, and yanked out their funds. Is the Chairman suggesting that the Federal Reserve or the U.S. Treasury should have stepped in and saved the National Bank of Kentucky, which was run into the ground by a swindler? The Fed was indeed asked to intervene in 1930 and refused to do so--and rightfully so. Many banks, like the Bank of United States in N.Y.C., lost the faith of their depositors for good reasons and they usually went under for good reasons. The Fed also declined to help the Bank of United States. Yes, those collapses caused shocks to the system, but the system was resilient enough to survive them and was better off without the offending institutions. That might be a better lesson for the Fed Chairman to learn from the Great Depression and parallels with the latest excitement on Wall St.