The U.S. Banking Panic of 1933 and Federal Deposit Insurance 1. In 1929 there were more than 25,000 commercial banks in the U.S. Today there are still approximately 7000 banks. In most other countries there are just a handful of major banks – often 4 to 8 institutions dominate the market place. What explains the vastly different character of the banking system in the U.S. from that of other countries? Similarly, most other countries have not in the past provided government sponsored deposit insurance, though some have put it in place as part of their response to the credit crisis. Does the unique structure of the U.S. banking system indicate a greater need for such insurance?
In 1933, banks in the United States were unsecure and there was widespread fear based on the previous closures. Depositors panicked as banks were experiencing difficulties. What differentiated U.S banks from other banks is that US banks were composed of two main banks: national banks that were following the federal law and regulation and which it could share funds and resources across US, and the State banks that were following the state law and regulations. It was proven after the crisis that local units banks were more vulnerable to the crisis than national banks. Many states restricted branch banks form developing that made some banks riskier and it limited their liquidity. In 1929 crash, customers were unable to pay back their loans that led to a severe liquidity problem as payment of loans and deposits provided most of the cash flow and backing of American banks, which led to bank closures. From another point, the absence of a central bank is another difference between US and Germany or Great Britain. It was surely one reason of the severe crisis that affected US Banks. Due the lack of presence of central banks and absence of a leader that could limit the failures and restore confidence in the system made the insurance more needed in the US. In addition, the financial crisis in Europe affected the United States and weakened the American gold reserves that have limited the resources of the Fed to help the commercial banks. All those factors, led to a severe financial crisis in the US and those US factors were as well the reason of the more frequent and severe banking crisis than in Europe. For the reasons above and due to the frequent banking crisis that hit the US commercial banks depositors lacked confidence in the banking sector, that some had to keep their money at home. The debate was always present at that time concerning the deposits insurance. The deposit insurance is mainly to prevent bank runs and enhance stability of the financial system. Depositors are unable to tell a good bank from a bad one so whenever they hear bad news about a bank they run to the bank to withdraw their monies. But it believe this will lead to maral hazard as some depositors will not monitor the bank and the bank may as well increase their risk. Moreover at the state level, the deposit insurance funds were established between 1907-1917 but in 1931 the opponent of these programs proved that the programs had failed. There was always a “try” to insure the deposits so the depositors trust the financial system again. Roosevelt as well was opposed to the “guarantee of funds” as he believed that the government should guarantee the good banks and the bad ones and this will eventually lead to a probable loss. Instead he proposed to “cleanup the banking situation” rather than “a stopgap guarantee”. In order to have a stable financial situation and stability in banks, regulation should be made to oversee the banking operation and rules should be clear enough for banks to follow. On another hand, I think that the “Cleanup” idea of president Roosevelt was in the right place, as we can not progress if we still have weak points in our system, mergers and acquisition can be a good solution for that situation. Reference: * HBR Case: The U.S. Banking Panic of 1933 and Federal Deposit Insurance * http://depts.washington.edu/depress/bank_crisis_1933.shtml

2. As the case study notes, the banking panic of 1933 was not unique. There had been many previous banking panics periodically over the previous century. What made the banking panic of 1933 so extraordinary that it required significant action on the part of the U.S. government?
The US commercial banking experienced several financial crises between 1814 and 1933. One of the most critical one was in the 1930-1933. The significant aspect of the great depression was the confidence in the banking system. The weaknesses of the banking system begun in 1930 and it grow to reach its peak in 1933. Before 1930, it was a phase of financial stability and a good economic environment where everyone trusted the banking and financial sectors. Companies were generating profits and were able to finance their operations without having the need to borrow money from financial institutions, depositors increased their deposits, which gave the banks the opportunity to increase their assets and invest more in securities and real estate holdings. In 1930 when the volume of production and construction started to decline and the stock market declined many economic indicators got affected as well, like unemployment rate inclined to reach 25% of the labor force and many banks closed their doors. As a result of the bank closures, money supply was reduced and with less money circulating, the purchasing power of consumers were reduced. The cycle was hit again, with less money with consumers meant less purchase that led to losses for companies as they are offering a lot more than the demand. This situation led the companies to cut the work force. By the end of 1932, more than 13 million American workers were unemployed. Anxious citizens withdrew their deposits from banks and hoarded cash and gold. The crisis didn’t stop; it hit almost most the United States banking system such as Detroit. The panic started in Detroit when the sales of automobile fell drastically, workers lost their jobs and they were not able to pay back their loans. Many banks closed that period. After Detroit crisis, the panic spread all over US. Due the critical situation and all the impact of such a scenario, different government interventions started to limit the crisis as an example the Michigan holiday that announced a banking holiday for eight days. At that time Roosevelt suspended all transactions in the Federal Reserve as well as other banks and financial institutions. Also, he stopped the export of silver, gold, and currency. During that time, the Congress met in special session to find a solution for the crises. The Emergency Banking Act was one of the solutions passed by Congress and Roosevelt signed it. At a later stage, the President recognized all insolvent banks and he reopened sound banks without delay. He implemented his idea of “cleaning up the system”. In summary, due to all those effect of the Great Depression, from the erosion of confidence in the banking system and the increase in unemployment rate, less money in circulation that affected the production and the closure of many banks were the main reasons that required the intervention of the government.
Reference:
* http://en.wikipedia.org/wiki/Banking_in_the_United_States#History * HBR Case: The U.S. Banking Panic of 1933 and Federal Deposit Insurance

3. Similarly, what was so extraordinary about the credit crisis of 2007-2010 that it has become the centerpiece of economic policy and required such unusual actions as bailouts, government injections of equity into financial institutions, emergency lending facilities, etc.?

In the 2000s, the US banking sector experienced the hardest financial crisis after the great depression. The Great Depression of the 1930s and the Great Credit Crisis of the 2000s had similar causes. First, the industrial production fell drastically just as the great depression that led to an unstable economic conditions and raised the unemployment rate. Less money was circulating that affected companies financial stability. The liquidity problem faced the Unites States banking system, which led to several closure and collapse of some financial institutions. Second, the real estate crisis in the 2006 that damaged financial institutions and damaged investor confidence, which affected the stock market that declined drastically. As part of the housing boom, the market of mortgage-backed securities increased greatly and many financial institutions that had borrowed and invested heavily on the real estate sector reported significant losses due the decline of the housing prices. It is important to note that the dramatic losses in the overall stock market over the 2000 to 2002 period is somehow close to the 80% decline in the Dow Jones Industrial Average between 1929 and 1932. The financial crises of 2000s questioned the rating agencies and the government practices. The crisis was a result of high-risk complex financial products such as hedge funds, moral hazard and many other factors. The same reasons of 1933 led the government to interfere and limit the collapse of the financial system. The government responded with an emergency and short-term response. The government made the largest liquidity injection into the credit market and they also raised the capital of the national banking system by $1.5 trillion. The effect of the financial crisis had affected many other countries such as European countries and others, which was also one of the reasons that needed the intervention of governments to limit the Global Financial crisis.

Reference: http://en.wikipedia.org/wiki/Banking_in_the_United_States#History 4. Perhaps the best known quotation of Roosevelt's was "The only thing we have to fear is fear itself". How does the thought behind that quotation fit into the provision of Federal deposit insurance? How does it relate to the response by governments around the world to the current credit crisis?
What Roosevelt meant by “ the only thing we have to fear is fear itself” is that the US economy can get better if people, mainly depositors, had confidence in the banking system and US economy as whole. If people had confidence they wouldn’t “run to the banks” to get their money back and by that they wouldn’t affect the liquidity of the banking sector. The fear was the reason of the Great depression and the Global financial crisis. So he made the statement in an attempt to calm the panic and hopelessness that had affected the American people because of the Great Depression. On another hand, many governments around the world responded to the global financial crisis in different way. For example, in the U.S the Fed lowered the Fed rate to provide additional liquidity to the financial system, expanded the range of collateral it would willing to accept in return for loans, and provided direct lines of credit to a broader variety of financial institutions. In Australia the government interfered regularly to support its currency and it announced it will guarantee all banks deposits for a certain period of time and also the central bank cut the interest. In Europe and more specifically in Germany, the parliament approved to inject 500 billion euros to rescue financial institutions. To avoid the collapse of the financial system and to avoid the run to banks, Germany announced as well that the government would guarantee all the deposits. So it is clear that around the world the Global financial crisis affected the entire continent and mostly every country. The governments interventions was basically the same, every country tried to protect its baking system by guaranteeing the deposit over a period of time to limit the withdrawal of deposits and to avoid the collapse of the financial system, as it is believe that such a collapse is contagious and knowing the globalization effect, a certain Global bank can affect several countries leading to a global disaster.

Reference:
BBC news: Financial crisis: World round-up
Credit crisis: http://www.investopedia.com/university/credit-crisis/credit-crisis6.asp