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.

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.