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.

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.