Introduction: How does finance change the world?
In fact, finance only does two simple things. It is like an economic time machine, helping frugal people transfer their surplus to the future or giving borrowers an opportunity to earn more money in the present. It can also be transformed into a safety net, with good insurance to prevent floods, fires, and diseases. By providing these two services, a coordinated financial system can effectively help overcome the peaks or valleys of life and make the world harmonious and full of love. In addition, when investors shuttle through the world searching for the most profitable ways, finance becomes the engine of economic growth.
However, finance is also highly destructive. When the foam bursts and the market collapses, the future business plan for many years will disappear. When the subprime crisis of 2008 came roaring, leaving behind a flood of unemployment and widespread debt. We should ask ourselves whether we have done the right thing to harness the benefits of finance and eliminate its toxicity.
Using history as a mirror, we can understand the rise and fall. The five devastating financial recessions – from the first financial crisis in the United States in 1792 to the global Great Depression in 1929- pointed to two major trends in financial reform. Firstly, the various institutions that have increased residents’ financial participation, such as central banks, deposit insurance, and stock exchanges, are not geniuses in peacetime, but rather pieced together remedies under the brink of financial crisis. It is precisely the dog skin plaster remedy after the crisis that gradually became a permanent part of the entire system. If history is correct, any decisions made today will echo in the coming decades.
This makes the second trend even more troublesome. We follow the usual pattern in dealing with crises. First, start spraying. The newly constructed parts of the financial system have been criticized: new types of banks, speculators, or assets accused of being the culprits will be banned or planned for elimination. Ultimately, it ends with public assistance to the private market, while another essential part of the financial system provides state support. All of this seems quite wise and reassuring.
But doing so is old and decadent. Walter Bagehot, the editor in chief of our magazine from 1860 to 1877, argued that the cause of financial panic was the influx of “blind capital” from the public into unwise speculative investments. However, those well intentioned financial innovations have increased the severity of the problem. The UK’s use of £ 35000 from national savings to support Iceland’s banks will make the knowledgeable Zhihao restless. The fact that professional investors can rely on the state will make them even more furious.
The next five crises tell the story of the origins of modern financial giants – the New York Stock Exchange, the Federal Reserve, and the Great Bank of Britain. It points out how successful financial innovations will protect investors from danger, while also warning regulatory agencies in the later stages of the crisis.
1792: The Foundation of Modern Finance
Modern finance has both its benefits and its terrifying side. If we were to attribute these two sides to one person, it would be Alexander Hamilton, the first Secretary of the Treasury in American history. In 1790, just 14 years after declaring independence, young America was still a blank slate in finance, with only five banks and some insurance companies. Hamilton wanted to establish a world leading financial system, just like Britain or the Netherlands at that time. This means that the independent debts of each state can be consolidated under the name of federal debt. The newly issued treasury bond of the United States will be freely traded in the market, which will enable the country to raise funds cheaply. At the same time, the United States needs a central bank, the National First Bank (BUS), which will be owned by the public.
This new bank will be an exciting investment opportunity. Out of BUS’s $10 million stake, $8 million will be distributed to the general public. The first auction in July 1791 went very smoothly and was sold out within an hour. Hamilton was very happy about this, because the two pillars of his planned system – BUS and treasury bond – were designed to support each other. To get the $400 shares of BUS, investors must buy a certificate called “receipt” with a price of $25. For this reason, they must pay three fourths of the nominal price (25 * 3/4=18.75 $). They can only pay by buying treasury bond instead of cash. In this way, the demand for treasury bond has soared, and the banks have sufficient reserves. All of this seemed so beautiful: in August 1791, the receipt price skyrocketed from $25 to $300. The National Bank opened in December.
However, two things posed hidden dangers to Hamilton’s plan. One thing is the mischief of my old friend William Dur. In this American financial crisis, that cunning old Etonian was the first but not the last person to be condemned. Duer and his associates learned that investors need treasury bond to buy shares in BUS, so they set about hoarding it. To raise funds, Du Er borrowed money from wealthy friends and issued IOUs to anyone he met. Of course, he also misappropriated funds from the company he managed.
The second issue is the bank itself. On the first day of its opening, it set aside all other competing banks. The loan amount is huge, and it has rapidly expanded, lending $2.7 million in the first two months of its opening. In the mode of unlimited credit, residents of Philadelphia and New York have all fallen into speculative frenzy. The number of short-term transactions and forward contracts in the market is surging. Every week, 20 carriages collide back and forth between two cities to seize opportunities and engage in intense arbitrage.
Something seemed off in March 1792. BUS is very low in hard currency trading and has started to withdraw bank notes. The unlimited credit model suddenly changed, and the number of loans dropped by 25% between the end of January and the end of March. Due to the credit crunch, Du Er and others have lost the way to repay old loans with new loans, and are extremely anxious.
The rumors about the Duel difficulties and the fact of BUS credit tightening caused a sharp decline in the US stock market. The price of treasury bond, the value of BUS shares, and a small number of other listed companies’ shares fell by 25% in two weeks. On March 23rd, Du Er was arrested and imprisoned. But that didn’t stop the downward trend, and the company began to go bankrupt. Pain and anger pervade together. Angry investors gathered and threw stones at the New York prison where Dur was being held.
Hamilton is well aware of the situation on the card. As a student of financial history, he is well aware that the financial collapse of France in 1720 left its financial system struggling for many years. Furthermore, Thomas Jefferson is waiting patiently for everything he has worked hard to establish to collapse. According to Richard Hilla of New York University in 2007, his response was the first financial aid to a bank in American history. Hamilton launched a multi line counterattack: using public funds to buy treasury bond bonds to regain the price, helping protect banks and those speculators who bought at high prices. He injected capital into troubled creditors. In addition, it also guarantees that banks with collateral can borrow money freely at a rate of 7% (the upper limit of the interest rate at that time).
Although these measures are highly effective, there is a debate about how to avoid possible future decline. Everyone agrees that finance is too easy to bubble. In order to prevent foolish outsiders from entering the danger of investment again, law makers imposed an absolute ban. In April 1792, New York City passed a law that expelled the public from the forward trading market. In response to this strict regulation, 24 businessmen gathered on Wall Street — under the wutong tree, according to legend — to establish their own private trading club. And this club is the predecessor of the New York Stock Exchange.
Hamilton’s financial aid was quite effective. With the rebuilding of confidence, finance blossoms and bears fruit. Within half a century, New York became the absolute ruler of the financial industry: both the number of banks and the stock market surged, and the gross domestic product steadily increased. But this rescue also caused other consequences. Hamilton set a precedent for financial aid banks. During the subsequent crisis, financial institutions became increasingly reliant on government intervention.
1825: First stock market crisis
Crisis always comes with hope. In the 1820s, as Latin America broke free from Spanish control and gained independence, the world became excited. Investors, especially the large group of British investors at that time, were keen on searching for various emerging forces. At that time, Wales was the world’s capital of raw materials, producing 3 million tons of coal annually and transporting pig iron to various parts of the world. Manchester is becoming the world’s first industrialized city by processing raw materials into high-value goods such as chemicals and machinery. Industrial production in Britain increased by 34% from 1820 to 1825.
Naturally, cash rich Britons want to invest to make money. During the Napoleonic War, treasury bond met the demand for investment, but as the war neared its end (the danger was reduced), the Ministry of Finance began to reduce the interest rate of treasury bond. In 1822, the interest rate of 5% of treasury bond was reduced to 3.3% in 1824. In the case of an inflation rate of 1% from 1820 to 1825, the actual return on treasury bonds was too low. Safe, but he’s not attractive anymore.
Fortunately, there are new investment options from abroad. In 1820, London had already replaced Amsterdam as the most important financial center in Europe and was the focus of foreign government bond issuance. The emerging global bond market is developing at an incredible pace. In 1820, there was only one foreign bond in London market; But in 1826, the number increased to 23. Bonds from Russia, Prussia, and Denmark were priced reasonably and sold out quickly.
But the truly exciting investments come from the emerging world. The crumbling Spanish Empire has recognized the independence of its former colonies into independent nations. From 1822 to 1825, Colombia, Chile, Peru, Mexico, and Guatemala successfully sold £ 21 million worth of government bonds in London (equivalent to $2.8 billion today). In addition, there are other ways to throw money into the lottery: the stocks of British coal mining companies planning to explore the New World are quite hot. Taking Anglo Meixican as an example, its per share price rose from £ 33 to £ 158 within a month.
However, the biggest problem is simple: distance. It takes at least six months to travel to South America, and the information relied upon by all exchanges is quite rough and sloppy. The most prominent example is Gregor MacGregor successfully selling the government bonds of the newly fabricated country “poyais”. This shocking scam is a sign of serious corruption. Investors are holding quite inaccurate checks in their hands. Most of the information about the new country comes from journalists who charge promotion fees. A person with a clear mindset would ask themselves: Mexico and Colombia do exist, but they only have the most basic tax system, so how can they raise money to repay principal and interest?
Investors also hold onto some fascinating conclusions. Everyone understands that as a competitor to Spain, Britain will inevitably support the independence of Latin American countries. But investors go further. Because Madrid’s enemy is London’s friend, they estimate that those new countries will rely on Britain to seek financial support. Looking at the 6% guaranteed government bonds of Mexico and Colombia, it seems that there is not much risk compared to the 3% British government bonds. It’s obvious which one to buy.
But the UK did not support any of these new countries. In the summer of 1823, Spain was already on the brink of collapse. Anxiety began to spread and bonds began to decline. A survey by Marc Flandreau from the Geneva Institute and Juan Flores from the University of Geneva showed that by the end of 1825, the price of Peruvian government bonds had dropped to 40% of its price, followed closely by bonds from other countries.
Under the influence of the debt of coal mining companies, British banks have been greatly affected. Depositors flocked to cash in, but the bank was still open in December 1825. The British bank stepped forward not only to provide funding for lenders but also to directly assist struggling companies, which is equivalent to the function of a central bank today. Despite this, many banks are still unable to cash out depositors’ book amounts. In 1826, over 10% of banks in England and Wales went bankrupt. The UK’s response to this crisis will determine the overall trend of the banking industry.
The most profound aspect of the 1825 crisis was how lawmakers should respond to its sharp divisions. Some people blame investors for their irresponsibility: they throw money to countries that exist or do not exist, to mining companies that do not understand exploration. The crisis in the stock market naturally requires investors to carefully check their investment projects before making any investments.
But Britain’s finance minister has pointed the finger at banks. Small team partners are connected with modern private equity companies, and they are accused of disorderly lending that led to the expansion of the speculative foam. At that time, the banking law stipulated that banks could form teams of up to six people to ensure fairness, resulting in larger banks with smaller volumes. Everyone is debating whether to make banks bigger so that they have the strength to withstand inevitable shocks.
Thoughtfully and thoughtfully, the people of Westminster and Lide Street turned their gaze to northern Scotland. Its bank implements a “joint stock” system, where lenders can form an unlimited number of partnerships to ensure fairness for newly admitted members. The Bank of Scotland handled the crisis quite well. In 1826, the British Parliament passed a new banking law to restructure the banking industry. At that time, England was already the bond center of the world. With the lifting of the limit on the number of bank partners, banks in various counties have gradually been eroded by competitors like the Royal Bank of Scotland, and this process has continued until now.
The transformation of joint-stock banks is a bittersweet moment in the history of British finance. This is a earth shattering change: the ancestors of modern super banks have been born, and Britain has begun to lead the world’s banks while leading world bonds. The gradual merger also explains why RBS became the world’s largest bank and the largest bankrupt bank in 2009. Nowadays, the four major banks in the UK hold nearly 75% of the national savings, and the threat of any one of them collapsing could pose a systemic danger to the economy.
1857: The First Global Financial Crisis
By the mid-19th century, people around the world had become accustomed to financial crises. Britain seems to be following the tradition of ‘collapsing every ten years’: after 1825-26, it experienced the Panic of 1837 and 1847. According to the pattern, the collapse of 1857 had no novelty. But this time it’s different. A shock from the Midwest of the United States crossed the American continent, leaping from New York to Liverpool, Glasgow, and then London. Next is the collapse of Paris, Hamburg, Copenhagen, and Vienna. Financial collapses are no longer just cyclical – they are also global.
On the surface, Britain did quite well in the mid-19th century. A large amount of goods are exported to various parts of the world, and with the continuous growth of raw materials excavated from Australian gold mines. But upon further observation, two major changes are happening. Together, they will create what our magazine described in 1857 as’ a more severe and widespread unprecedented crisis’.
The first change is that a global economic network has been formed. On the one hand, it facilitates trade. In 1857, the United States held a deficit of $25 million in trade with Britain and its own colonies. Americans buy more and sell less, while the UK buys American assets to provide cash, which is what China is doing today. In the mid-1950s, Britain bought $80 million worth of US stocks and bonds.
Railway companies were a hot investment direction at that time. For example, most of the stocks of American railway companies such as Illinois Central, the Philadelphia, and Reading are owned by British investors, thereby gaining decision-making power. This makes the British indifferent to the future of any industry beyond profits: they are all betting on the future growth of railways.
The second change is the significant innovation in the financial industry. When the aggressive Union Bank of Britain absorbed a large number of competitors, the savings growth from 1847 to 1857 reached 400%. A new type of lending party – discount intermediaries – has sprung up like mushrooms in London. This type of new institution originated from intermediaries between investors and cash strapped companies. At that time, with the prosperity of finance, discount intermediaries also emerged. After convincing investors that they could withdraw their investments at will, intermediaries took their money to search for companies in need of funds. In short, they are anonymous banks.
The competition is so fierce. Because the interest rate paid by Union Bank to depositors is one percentage lower than that of British banks, the interest rate of discount intermediaries must be higher than it to attract funds. But the central bank also engages in discount business, taking away the best bills and adding an interest rate cap to the borrowers of discount intermediaries. So it can only play within a range of one percentage point, discount intermediaries must go into battle lightly. Because holding cash does not yield any returns, they have reduced their savings to the extreme, as they can always borrow money from the central bank without fear. Faced with frequent borrowing in the long run, the new financiers in London have reorganized the reserve requirements for funds.
At the same time, in the United States, Edward Ludlow, the manager of an insurance company called “ohio life,” was caught in the railway heat. A new railway line has been built to connect eastern cities with remote areas. People are investing heavily, but Ludlow is fully invested. Bet $30000 out of $480000 on the railway company using the ‘ohio life’ company. A single investment on the Cleveland and Pittsburgh routes consumed a quarter of the entire insurance company’s funds.
In the spring of 1857, railway stocks began to decline. The stock of ‘ohio life’, which was overexposed through leverage, fell sharply and declared bankruptcy on August 24th. According to the research conducted by Charlie Keromiris from Columbia University and Larry Schweickart from Denton City University, the disaster spread eastward and destroyed stockbrokers who invested in railways. When the bank sold these stocks, the prices plummeted and the losses were huge. On October 13th, depositors on Wall Street demanded to withdraw their cash. The bank refused to realize the redemption. The US financial system is paralyzed.
Graces and Liverpool. Merchants who conduct transactions with American companies have been injured since January. But there are also direct financial connections, as a US bank called “Dennistoun, Cross and Co.,” with branches in Liverpool, Glasgow, New York, and New Orleans, collapsed on November 7th along with the Western Bank in Scotland. This caused a systemic crisis in the UK: the bank had 98 branches holding £ 5 million in national deposits. At this moment, it is urgent to calm down the panicked people.
And discount intermediaries have magnified the severity of the problem. They are a flexible and important source of funding for the company. But investors are very worried about their balance sheet. You should also be worried: a company with 10000 pounds can leverage a risky loan of 90000 pounds, which exaggerates the leverage ratio even beyond modern levels. When discount agencies collapse, ordinary small companies also follow suit. In the last three months of 1857, there were 135 bankruptcies, which wiped out £ 42 million of investors’ funds. And Britain’s deep economic and financial involvement in Europe brought panic into Europe.
As a global crisis, the collapse of 1857 marked another first time: people recognized that financial security measures could pose extreme risks. Discount intermediaries themselves are taking big risks, holding very little liquidity and a small amount of asset reserves, because they know they can always borrow from the Bank of England. The bank, which was very unhappy about this, changed its policy in 1858. Discount intermediaries can no longer borrow indiscriminately. They must hold reserves to ensure themselves and can no longer rely on the central bank. This step made the crisis of 1857 a rare example of a government withdrawing financial aid. This also shows how painful and unpleasant it is to revoke subsidies.
The Bank of England seems to have been “heartbroken” by the unprincipled reliance on discount intermediaries, and then reformed to the extreme side. The Economist magazine believes that its overly strict loan policy appears to be unprincipled: we argue that whether or not to lend should be decided based on the actual situation of each case, rather than a blanket denial. Others believe that the central bank is untrustworthy and would never let a large discount intermediary go bankrupt. But they were wrong. In 1866, when ‘Overend&Gurney’ needed a large amount of cash to cash out to major clients. The Bank of England refused to rescue it, thus wiping out all shareholders. Britain thus enjoyed 50 years of financial peace, which some historians attribute to the banks’ careful consideration of their own security defenses and their escape from moral traps.
1907: Emergency Relief Funds
As the 20th century approached, the United States and Britain implemented completely different banking systems. The National Bank of the UK is almost omnipotent, and a system with banking industry foremen has been established and completed. However, the United States is completely opposite in this regard. The BUS established by Hamilton had already ceased operations as early as 1811, and its successor was only confined to a corner of Philadelphia and closed in 1836. A decentralized system has developed. Americans believed that banks could take care of themselves until the crisis of 1907.
The absence of the ultimate leader in the banking industry will certainly not prevent the rapid development of the industry. After the end of the civil war, the number of banks began to surge. By 1907, there were already 22000 banks in the United States – an average of one bank per 4000 people. In the vast majority of towns, people can choose to deposit money at state banks or local banks.
However, regardless of these choices, clever ordinary people are willing to invest their money in another place – trust companies. This form of institution originated from the “custodians” of the early 1890s, who held customers’ money in the form of bonds or stocks. In 1907, high-risk activities were carried out together with secure mortgages: guaranteeing and distributing stocks and property, managing property and railways. They still maintain their deposit business. This type of trust company is actually a bank.
In addition, they are rapidly developing and compared to ordinary banks, they invest in high-risk assets with few constraints. Compared to banks that must hold a 25% reserve (in case of sudden collective redemption), trust companies only require a minimum reserve of 5%. Due to the ability to pay high interest rates, trust companies have become a gathering place for large amounts of funds. By 1907, their scale was almost the size of a bank and had grown by nearly 250% in just over a decade.
The United States is also rapidly advancing. Between 1896 and 1906, its average annual growth rate reached 5%. This is very unusual, especially after major disasters such as the 1904 Baltimore Fire and the 1906 San Francisco earthquake, which each wiped out nearly 2% of GDP. All Americans, you would feel grateful if everything remained at its original level.
But according to documents disclosed by economists Ellis Tallman and Jon Moen of the Federal Reserve in 1990, two insatiable fraudsters, Augustus Heinze and Charles Morse, wanted more. These two bankers (scumbags) borrowed and misappropriated a large amount of funds in an attempt to sell copper in the US market. But in 1907, the speed of economic development began to slow down, and the prices of raw materials, including metals, naturally decreased. US copper stocks subsequently fell, with Heinze and Morse suffering heavy losses due to massive hoarding. To salvage the defeat, they began to use the funds of the banks they managed. This endangered the small loan party and ignited the fuse that ultimately dragged Knockerbocker Trust Company down.
The most expensive streets in Manhattan are 34th Street and 5th Street, where savings skyrocketed from $10 million in 1897 to $6000 in 1907, making it the third largest trust hub in the United States. The Collins style cylinder even extends all the way to its neighbor Waldorf Astoria. The marble inside comes from Vermont; And the outside comes from Norway. A look of wealth and resilience.
On the morning of October 22nd, the knockerbocker looked so steady. When the news revealed its involvement in the financial failure of Heinze horse, depositors formed a long queue to cash out. Knockerbocker cashed out $8 million in just one day, but it refused some acceptances and kicked the ball to other trust companies. American trusts have also experienced a frenzy of redemption, followed closely by Lincoln Trust. New Yorkers first move money unpredictably from one trust to another. When the financial system became visibly insecure, everyone hid their money at home.
For a while, it seemed like this crisis could nip it in the bud. After all, the economic slowdown was minimal, with GDP still growing by 1.9% in 1907. Despite some dishonest people like Heinze and Morse causing trouble, giants like John Pierpont Morgan still sit on the other side. When the panic spread and interest rates reached 125%, Morgan took action and pooled cash to help ease the situation. In this way, he brought the entire New York Bank under his control until the intervention of $25 million in financial aid.
But it’s still not enough, depositors across the country are moving money back home. Collapse seems to be imminent, and the country has announced an emergency holiday law. Banks that insist on opening have also restricted withdrawals. Despite the strong economy, the collapse of New York City triggered a nationwide money crisis. This dealt a heavy blow to the production business, and from 1907 to 1908, the national production output decreased by 11%.
When legal tender is so scarce, the general public immediately exerts subjective initiative. In most major cities in the United States, cash substitutes are beginning to flow. Among them are checks and small denomination bank loan notes. All of these privately made emergency cash – all illegal – amounted to as much as $500 million, far exceeding Morgan’s aid. It did indeed work, and by 1909 the US economy was back on track.
The initial reconstruction plan naturally aimed to address the shortage of currency. An official emergency relief fund of $500 million was quickly released. But this aid will have a long-lasting impact. The new currency regulations include establishing a committee – the National Monetary Council – to explore how the US currency should operate. The National Monetary Committee has spent four years collecting a large amount of data from around the world to observe how to reconstruct the system. The ultimate conclusion is that the central bank is indispensable. The result was the establishment of the Federal Reserve, the third central bank of the United States, in November 1913. In the end, Hamilton’s plan was followed.
1929: The biggest one
On the eve of the 1929 recession – the worst Americans had ever seen – everything was beautiful. In the 1920s, the automotive and construction industries were thriving, and the stable employment rate brought by industry increased wages and consumption. Ford was able to produce 9000 Hyundai Model T cars in a day and invested $5 billion in new residential buildings in 1925. Although there were fluctuations (a decrease from 1923 to 1926), the power remained strong.
The bank also appears to be in good condition. In 1929, the combined balance of income and expenditure of 25000 banks in the United States amounted to $60 billion. Their assets seem to be very cautious: 60% are loans and 15% are cash. Even investing 20% in securities is quite wise: the lion’s share held is bonds, with over half of them being completely risk-free government bonds. Due to holding such high-quality assets, banks allow capital buffers to reduce the decline in losses.
But in the 1920s, the young Federal Reserve encountered a strange thing: stock prices and physical prices began to move in completely opposite directions. With the development of popular emerging technologies such as radio, aluminum products, and airplanes by listed companies, the stock market has surged. However, these emerging products have little record of dividend payments, and investors buy in large quantities in anticipation of their prices rising again and again. However, at the same time, as consumption decreases, trade in reality becomes declining. For a while, the Federal Reserve was torn between raising interest rates to cool down the market or lowering rates to warm up the economy. In the end, the market observers emerged victorious, and the central bank raised interest rates in 1928.
A catastrophic mistake. From 3.5% to 5%, Gally couldn’t stop the sharpness of investors: stocks continued to soar until September 1929, when the Dow Jones Index reached 381 points. But this severely damaged the basic industries of the United States, causing a 45% decrease in annual productivity. Tragedy both domestically and internationally. The arrest of financial fraudster Clarence Hatry in September triggered the collapse of the London Stock Exchange. The frenzy of selling has quietly arrived. What is shocking is that within just two days, on October 28th and 29th, the Dow Jones Industrial Average fell by nearly 25%. On November 13th, it had already dropped to 198, with a decrease of 45% within two months.
Even worse has come. Wave after wave of bank failures. In 1930, the first was the collapse of agricultural banks in states such as Kansas City, Illinois, and Missouri. That year, a total of 1350 banks disappeared without a trace. In April 1931, the second wave hit Chicago, Cleveland, and Philadelphia. The pressure from abroad has intensified domestic anxiety. After Britain abandoned the gold standard, its exchange rate plummeted, putting immense pressure on American exporters. Bank panics have also occurred in Australia and Germany. When public confidence is lost, people start hoarding currency again. A bond buying campaign launched by the Federal Reserve only brings a breath of relief, as the situation of surviving banks is distorted.
Everything became clear in February 1933. Ultimate panic, nationwide this time, with Nevada lowa、 The closure of the first banks in Louisiana and Michigan forced the implementation of more emergency bank holiday laws. The inland bank claimed that the New York Bank took away $760 million from their interbank loans in February 1933. Naturally, banks from various regions are seeking assistance from the Federal Reserve. But something unexpected happened. On March 4th, the Federal Reserve did something completely contrary to its purpose, refusing any assistance. The Federal Reserve has failed to fulfill its mission as an emergency aid for all funds. A week-long bank shutdown has begun.
This is the darkest week in the history of American finance. Government officials have carefully examined the bank’s books and found that over 2000 banks have never opened after this closure. Before things slowly improved, almost 11000 banks went bankrupt from 1929 to 1933, and the currency supply decreased by 30%. Only 3.2% of the business rate rose to 25% during the crisis; It was not restored until 1940. And it took 25 years for the Dow Jones index to return to its peak in 1929.
Reform is urgent. The first step is to reply to the system by injecting a large amount of public funds in a short period of time. A total of $1 billion in support – equivalent to one-third of the entire banking system – was injected into 6000 out of 14000 banks. By legislating to ensure that future risks are evenly distributed, the Glass Steagall Act separates stock operations from ordinary lending, giving the federal government greater power to constrain bank loans to those used for investment.
A new government agency was established to manage the operation of the banking industry: the Federal Deposit Insurance Corporation (FDIC) was founded in January 1934. Reduce the losses caused by bank failures by protecting customers whose savings value reaches $2500 per person. Restricting depositors’ losses is beneficial for returns, money supply, and purchasing power. Because depositors can trust the FDIC, they will not run on banks due to minor financial fluctuations.
On one hand, it surprisingly works. Banks quickly declared themselves to have FDIC guarantees, which can ensure zero risk for customers’ savings. The history of banks operating independently for 70 years has passed. Now banks can reduce the high cost cash flow and reserve funds that decrease annually. An inefficient self-protection system has come to an end, replaced by a low-cost, risk sharing system backed by a central bank and savings insurance.
However, this is not what Hamilton wanted. He wants the financial system to support the national economy, and banks and stock markets to support treasury bond, so that society and the military can operate at a low cost. But in 1934, a completely opposite system was established: now it is supported by the state for financial stability, not the other way around. By transferring risks to taxpayers, the evolution of the financial industry has created a distorted subsidy at the center of capitalism.
The fate of major banks in the UK and the US in recent years has shown the true cost of such subsidies. In 2008, Citigroup and the Royal Bank of Scotland Group, which combined assets of $6 trillion, were huge. However, the capital principal is pitifully small. When they exhaust their capital, the aid funds reach $100 billion. The other costs of protecting against banking crises are even greater – slowing economic growth, high debt, and heart wrenching employment expectations in several countries over the next few decades.
But financial assistance is imperative: allowing banks of that scale to collapse is even less cost-effective. The problem is not with national aid, but with having to do so. Understanding that the government must provide financial assistance to banks means that some financial professionals often take desperate risks. The bank’s debt is the first proof. The International Monetary Fund recently determined that the world’s largest banks received $630 billion in implicit government subsidies between 2011 and 2012. This enables cheap loans and exacerbates the leverage effect. However, in the United States, it is suggested that the government provide financial support to the mortgage market to recover 90% of the losses caused by the crisis. Once again, the public has taken on the risk of borrowing. Still the old trick.
Resolving such issues means transferring the risk back to private organizations. This requires great courage to make a choice. Withdrawing the subsidies enjoyed by banks will make debt more expensive, meaning shareholders will lose dividends and credit costs will also rise. Cutting off excessive savings insurance means that foolish investors who throw money at cunning banks suffer huge losses.
Startled by the recent crisis, planners are carrying out institutional reforms. They have an opportunity to change their identity as a financial umbrella. But complete weaning for businesses is not easy. As these crisis stories reveal, hundreds of years of financial history will be pushed in an unknown direction.