Nomi’s Note: Today I’m sharing an excerpt from my 2014 book, All the Presidents’ Bankers: The Hidden Alliances That Drive American Power.
The book tells the story of the hidden alliances between Wall Street and the White House. These alliances have driven American power over the last century.
Today’s excerpt takes us back to the 1930s. That’s when President Herbert Hoover tried to battle the Great Depression of 1929 and revitalize the economy.
During that time, hundreds of banks started shutting their doors. Businesses all over the country closed their stores.
Layoffs were in full swing. Unemployment rose dramatically. Industrial production dropped as consumer demand plummeted. Overall, both American families and the markets were suffering.
What’s more, the big banks were straddled with huge amounts of debt, just like today. So, instead of loaning money out to stimulate industries like agriculture, they were preoccupied with paying back their debt to the Federal Reserve.
That’s because our banking system is built to elevate the “Too-Big-to-Fail” banks above all else.
Fast forward to today, and we’re seeing a similar playbook. Five banks collapsed last year. The Fed stepped in to save them – by reversing its interest rate policy to print more money. And I’ve written about the problems in the banking system that still exist.
Last year’s banking crisis ended a run of 868 days with no bank failures. It was the second-longest in the U.S. since 1933. And that brings us back to the 1930s, and our excerpt for today…
[The excerpt below was adapted from All the Presidents’ Bankers: The Hidden Alliances That Drive American Power. Copyright © 2014 by Nomi Prins with permission from Bold Type Books, formerly Nation Books, an imprint of Perseus Books.]
A Godsend for Bankers
By Nomi Prins, Editor, Inside Wall Street with Nomi Prins
The banking system failures throughout Austria and Germany, and the Wiggin and Hoover moratoriums, were followed by Britain’s abandoning the gold standard on September 21, 1931.
The global Depression was in full swing.
In the United States, hundreds of banks were closing their doors. City landlords were throwing out more and more tenants for not making rent. Home foreclosures spiked. People couldn’t afford heating fuel during the harsh winter months.
Construction and other jobs disappeared. Smaller businesses weren’t making enough money to pay operating costs, let alone the interest on their loans. They didn’t get debt moratoriums; they just defaulted. Meanwhile, banks were steeped in self-preservation mode.
By mid-1931, mass layoffs were the ugly norm. Even Henry Ford shut down many of his car factories in Detroit, throwing seventy-five thousand men out of work.
The combination of strained lending for productive uses and bankruptcies of small establishments coalesced in widespread financial degradation. Meanwhile, big banks ceased lending to agriculture, industry, and local businesses in order to repay “a substantial amount of their borrowings at the reserve banks.”
Their first allegiance was to the Fed, which ensured their survival with cheap funds. This strategy would become a time-honored way for the most powerful banks to survive at the expense of their clients.
A few weeks after Britain went off the gold standard, a panicked Hoover held a secret meeting with thirty prominent American financiers at the Massachusetts Avenue apartment of Treasury Secretary Andrew Mellon.
As Irving Bernstein wrote in The Lean Years, “The president was overwhelmed with gloom and the fear of impending disaster.” He now saw “imminent danger to the American banking system as a consequence of the events in Europe.”
Blaming Europe for the woes of the US economy, however, was not looking at the full picture; it indicated a lack of understanding of the US bankers’ culpability in the crisis.
In his memoirs, Hoover remained detached and similarly unreflective of his or the bankers’ role, blaming the Fed and European bankers instead.
“To be sure, we were due for some economic readjustment as a result of the orgy of stock speculation in 1928-1929,” he wrote. “This orgy was not a consequence of my administrative policies. In the main it was the result of the Federal Reserve Board’s pre-1928 enormous inflation of credit at the request of European bankers, which, as this narrative shows, I persistently tried to stop, but I was overruled.”
To be fair, much of the laissez-faire attitude that had festered during the 1920s occurred during the Coolidge administration.
Hoover had attempted to steer bankers toward lending restraint, particularly internationally, and tried measures to bolster the economy after the Crash.
But by failing to examine the role of the financial community in providing the debt and fabricating the enthusiasm that stoked the speculation – not just in the market but throughout the economy – he failed to hold himself accountable for the frenzy of risky banking activity.
There were political opportunities lost in his denials, such as examining whether it was appropriate to have the chairmen of the largest banks in the country seated on the board of the New York Fed, as National City Bank chairman Charles Mitchell was, and had been before the Crash, and as Chase chairman Al Wiggin would be from January 1932 to March 1933.
(The alliance between the New York Fed and the financiers remains recklessly codependent to this day.)
Hoover did establish the Reconstruction Finance Corporation in 1932. The government bailout program was tasked with lending $1.5 billion to ailing banks and industries, but its funds were channeled disproportionately to the bigger banks.
One of those banks was the First National City Bank, whose chairman, New York Fed Class A director Charles Mitchell, had aggressively pushed the Fed to keep rates low after he realized that his bank and the entire financial landscape were in trouble.
The massive bond-buying program that the Fed initiated in May 1932, in which it agreed to buy $26 million worth of bonds a week from its member banks, reached a total of $1.82 billion in Treasury securities holdings.
The idea was that banks would sell their Treasuries and use the money to pay off their debts. After that, they would use the remaining cash to lend out or buy corporate bonds to help the greater economy. This was in addition to getting the benefit of low rates on their loans from the Fed’s discount window.
But only half of that plan happened. The banks did sell the Fed their government bonds to raise more capital. But they did not lend the money back out. (This tactic would be repeated after the 2008 crisis.)
As The Nation put it, “You can lead a horse to water but you can not make him drink, and you can offer the banks limitless Federal Reserve credit, but you cannot make them lend.”
Discount rates were eventually lowered to 2.5 percent in 1934, 2 percent in 1935, and 1.5 percent in September 1937. But this lowering of rates didn’t inspire an outpouring of lending either. The largest banks sat on their money.
The First Glass Bill
On February 27, 1932, Hoover signed into law the first banking bill championed by Virginia Democratic senator Carter Glass and Alabama Democratic representative Henry Steagall.
The primary purpose of the Glass-Steagall Act of 1932 was to protect the country’s depleting gold reserves by permitting government securities to be used to back Federal Reserve notes in excess of the prevailing 40 percent minimum threshold.
The act reduced the collateral required for Fed member banks to post at its discount window. It was a godsend for the bankers, giving them easier money in a tight credit market.
Thanks to the bill, banks no longer had to set aside gold to use as collateral for Federal Reserve notes.
With the extra money, they could reduce their own debt burdens rather than liquidate investments and loans, or sell them at bargain basement prices, to raise money. Bankers could also place more Treasuries on reserve at the Fed, so in a way the Fed was funding itself.
But actually, bankers, the Fed, and the Treasury (which issued the government securities instead of depleting gold) were all benefiting.
By the second week of May 1932 (when the act went into effect), member banks had pledged more than $98 million in new reserves to the Fed, more than half of which came from New York banks.