Mark D. Flood

Mark D. Flood is an economist at the Federal Reserve Bank ofSt. Louis. James P. Kelley provided research assistance. Theauthor would like to thank Bob Eisenbeis, Mark Flannery,Carter Golembe, and George Kaufman for many helpful com-ments. All remaining errors are the author’s.

The Great Deposit InsuranceDebate

In the stress of the recent banking crisis ... there was a very definite appealfrom bankers for the United States Government itself to insure all bankdeposits so that no depositor anywhere in the country need have any fear asto the loss of his account. Such a guarantee as that would indeed have put apremium on bad banking. Such a guarantee as that would have made theGovernment pay substantially all losses which had been accumulated, whetherby misfortune, by unwise judgment, or by sheer recklessness, and it mightwell have brought an intolerable burden upon the Federal Treasury.

—Sen. Robert Bulkley (n-OH),Address to the U. S. Chamber of Commerce, May 4, 1933.’

The only danger is that having learned the lesson, we may forget it. Humannature is such a funny thing. We learn something today, it is impressed uponus, and in a few short years we seem to forget all about it and go along andmake the same misiakes over again.

—Francis M. La~•v(1934), p. 41.

pA. HE ONGOING PROLIFERATION of bank and

thrift failures is the foremost current issue forfinancial regulators. Failures of federally insuredbanks and thrifts numbered in the thousandsduring the 1980s. The problem is especially im-portant for public policy, because of the poten-tial liability of the federal taxpayer. For example,by 1989, the Federal Savings and Loan Insur-

ance Corporation (FSLIC) was so deeply overex-tended—on the order of $200 billion—that onlythe U. S. Treasury could fund its shortfall. Thesignificance of insurance is seen elsewhere aswell: economists are quick to point to flat-ratedeposit insurance as a factor in causing the highfailure rates. Flat-rate deposit insurance is saidto create a moral hazard: if no one charges

‘Quoted by Sen. Murphy (D.IA) in Congressional Record(1933), p. 3008.

52

bankers a higher rate for assuming risk, thenbankers will exploit the risk-return trade-off toinvest in a riskier portfolio.

Why, then, do we have taxpayer-backed, flat-rate deposit insurance?’ A simple answer wouldbe that the legislators who adopted federal de.posit insurance in 1933 did not understand theeconomic incentives involved. This simple answerseems wrong, however, it has been pointed outthat certain observers articulated the problemswith deposit insurance quite clearly in 1933. Inthis view, the fault lies with the policymakers of1933, who failed to heed those warnings.

This fails to answer why policymakers wouldignore these arguments. Moreover, it does notexplain why it should have taken almost 50years for the flaws in deposit insurance to takeeffect. This paper examines the deposit insur-ance debate of 1933, first to see precisely whatthe issues and arguments were at the time and,secondarily, to see how those issues were treat-ed in the legislation. Briefly, I conclude that thelegislators of 1933 both understood the difficul-ties with deposit insurance and incorpot-ated inthe legislation numerous provisions designed tomitigate those problems.

The Banking Act of 1933 separated commercialand investment banking, limited bank securitiesactivities, expanded the branching privileges ofFederal Reserve member banks, authorized fed-eral regulators to remove the officers and direc-tors of member banks, regulated the paymentof interest on deposits, arid increased minimum

capital requirements for new national banks,among numerous lesser provisions. It also estab-lished a temporary deposit insurance plan lastingfrom January 1 to July 1, 1934, and a perma-nent plan that was to have started on July 1,1934.’ Although this paper focuses on depositinsurance, it is important to bear in mind thatboth the deposit insurance provisions of the billand the debate that surrounded them each hada larger context. The various provisions of theBanking Act of 1933 constituted an interdepen-dent package.

The deposit guaranty provisions of the billwere initially opposed by President Roosevelt,Carter Glass (Senate sponsor of the bill and Con-gress’s elder statesman on banking issues), Trea-sury Secretary Woodin, the American BankersAssociation (ABA), and the Association of Re-serve City Bankers, among others.~Despite thisopposition, on June 13, 1933, the bill passedvirtually unanimously in the Senate, with sixdissents in the Rouse, and was signed into lawby the President on June 16.’ Not surprisinglythen, the public debate preceding and surround-ing the adoption of federal deposit insurancewas active and far-reaching.

This paper is organized around the majorthemes of the debate: the actuarial questionsconcerning the effects of deposit insurance, thephilosophical and practical questions of fairnessto depositors and of depositor protection as anexpedient means to financial stability, and thepolitical and legal questions surrounding bankchartering and supervision. Much of the debate

2The Federal Deposit Insurance Corporation (FDIC) has re-cently announced a move toward risk-adjustment of its in-surance premia.

3The Act is often called the Glass-Steagall Act. It isreferred to here as the Banking Act of 1933 to avoid con-fusion with the separate Glass-Steagall Act of 1932. Sig-nificantly, it also has the longer official title: “An Act toprovide for the safer and more effective use of the assetsof banks, to regulate interbank control, to prevent the un-due diversion of funds into speculative operations, and forother purposes.”

The temporary plan was later extended, and the perma-nent plan delayed, for one year (to July 1, 1935) by theAct of June 16, 1934. The Banking Act of 1935 substantial-ly emended the permanent plan to resemble closely thetemporary plan. See the shaded insert on page 72 for fur-ther details of the various plans.

4The Federal Reserve did not adopt an official position,although there is some evidence of opposition: “Depositguaranty by mutual insurance is not part of the Presiden-tial program, nor is it favored by Federal Reserve authori-ties,” “Permanent Bank Reform” (1933); see also Kennedy(1973), pp. 217-18. Comptroller O’Connor favored depositinsurance; tormer Comptroller Pole opposed it.

5The Senate did not record a vote, although even Sen.Huey Long (D-LA), who had been a flamboyant detractor,rose to speak in favor of the bill. Cummings (1933) claimsthat the Senate vote was unanimous. The House dis-senters included Reps. McFadden (R-PA), McGugin (R-KS), Beck (R-PA) and Kvale (Farmer/Labor-MN). See“Congress Passes and President Roosevelt Signs Glass-Steagall Bank Bill as Agreed on in Conference” (1933), p.4192. Rep. McGugin’s request for a division revealed 191ayes and 6 noes; a quorum of 237 was reported present;Congressional Record (1933), p. 5898.

55

was motivated by economic and political self-interest and was structured rhetorically interms of morality and justice. Considerable at-tention is paid here to rhetorical detail.” Asmuch as possible, I have attempted to reportthe debate in its own terms—liberal use is madeof quotations and epigraphs—rather than riskmisconstruing the meaning through inaccurateparaphrase.

¶1 15 1 15 (21 2T fl TO r~tp .oj:.i2flzt.~..r.

The banking debate in 1933 covered not onlydeposit insurance and the separation of com-mercial and investment banking, but the fullcatalogue of financial matters: the gold stan-dard, inflation, monetary policy and the contrac-tion of bank credit, interstate branching, therelative merits of federal and state charters,holding company regulation, etc. By 1933, nearlyanything to do with banks or banking was animportant political issue.

T’h.r.~Grs~~.a.t(]o.n.t;rar.I~1ic’n

The people know that the Federal Reserve octopus/oaned .. to the gamblers of this Nation in 1928some sisty billion dollars of credit money—bankmoney—hot air ... and then when the crisis camein the last 3 months of 1929, cut that creditmoney—bank money—hot air—down to thirteenbillion.

No nation, no industry, can survive such anespansion and contraction of money and credit.Give to me the power to double the money atwill, and then give me the power to cut it squarein two at will, and I can keep you in bondage.~

It is reasonable to begin a recollection of thedebate over deposit insurance with the pricecollapse on the New York Stock Exchange of

October 29, 1929. The stock market crash waspopularly recognized as the start of the GreatDepression. The remainder of the Hoover ad-ministration’s tenure witnessed historic declinesin national economic activity. By the beginningof 1933, industrial production and nominal GNPhad both been cut in half; unemployment hadtopped 24 percent. Bank failure rates, whichhad already been high throughout the 1920s,had increased fourfold, while both money sup-ply and velocity had plummeted. The price levelfell accordingly.

For contemporary economic commentators,the stock market crash was more than a mar-ker between historical eras. For many, therewas a causal relationship between the stockmarket’s collapse and subsequent real economicactivity. in most cases, this causality was moreelaborate than post hoc ergo propter hoc. A pre-scient Paul Warburg, for example, warned inMarch 1929:

If orgies of unrestrained speculation are per-mitted to spread too far, however, the ultimatecollapse is certain not only to affect the specu-lators themselves, but also to bring about a gen-eral depression involving the entire country.’

The logic was that stock market speculation “ab-sorbs so much of the nation’s credit supply thatit threatens to cripple the country’s regular bus-iness.”9 A more radical theory was advanced bythe “liquidationists,” who held sway in influen-tial circles of government and the academy.’°For them, the cyclical contraction was a goodthing: it reflected the liquidation of unsuccess-ful investments that crept in during the boomyears, thus freeing economic resources for amore efficient redeployment elsewhere.

~Mostof what remains of the debate is formalized oratory:prepared speeches, Congressional debate, letters to theeditor, etc. Because the debate was a cacophony ofvoices, rather than an orderly dialogue, no attempt hasbeen made to present the arguments in chronological ord-er. A time line of the significant events of 1933 is providedin the shaded insert on page 55.

In terms of the written record, academic economists en-tered the debate late, for the most part after the BankingAct of 1933 had already been signed into law. See H.Preston (1933), Westerfield (1933), Willis (1934), Willis andChapman (1934), Taggart and Jennings (1934), Fox (1936)and Jones (1938). Phillips (1992) reports that Frank Knightand several colleagues at the University of Chicago advo-cated federal guaranty of deposits as part of comprehen-sive bank reforms proposed during the banking crisis inMarch 1933. Willis had been an advisor to Carter Glasssince the debate over the Federal Reserve Act in 1912.Guy Emerson, who published in the Quarterly Journal ofEconomics, was not an academician, but an officer atBankers Trust Co. and the 1930 president of the Associa-

tion of Reserve City Bankers; Emerson (1934) is largely aparaphrase of Association of Reserve City Bankers (1933),which he co-authored.

7Rep. Lemke (R-ND), Congressional Record (1933),p. 3908.

8Warburg (1929), p. 569.‘Ibid., p. 571.

‘°DeLong (1990) provides a valuable review of the liquida-tionist perspective. The Iiquidationists included Secretaryof the Treasury Andrew Mellon, as well as the economistsFriedrich von Hayek, Lionel Robbins, Seymour Harris andJoseph Schumpeter. More recent economic analyses havediscounted the role of the crash in causing the Depres-sion, emphasizing instead other forces, both monetary andnon-monetary; see Wheelock (1992a) and the referencestherein.

Crisis and ljnihniied Pnssihih’iv to induce our people to follow theii- false lead-

We are confused. We grasp, as at straws, for thesignificance of events and of proposed govern-ment action. Never before in our lives have wehad such great need for someone to interpret tin-deriving movements for our guidance.”

By 1933, the correlation between economic ac-tivity and bank credit was lost on no one. Dur-ing the interregnum between Floover’s electoralloss in November 1932 and Roosevelt’s inaugura-tion in March 1933, what had been a debilitat-ing banking malaise became a desperate crisis.Starting with Michigan, on Valentine’s Day,whole states began to declare official hank holi-days; elsewhere, individual banks in scores weresuspending withdrawals. By inauguration day,March 4, most states had declared a holiday.”Even much earlier, bank failures had left wholetowns without normal payment services, rele-gating them to barter.”

Theories of the connection hetween hankfailures, monetary contraction and the moregeneral macroeconomic torpidity were wide-spread and varied. Roosevelt, in his inauguraladdress, suggested that the set of people whocorrectly understood the nation’s economic prob-blems did not overlap with the set of peoplewho had held the reins:

Their effoits have been cast in the pattern ofan outworn tradition. Faced by failure of creditthey have proposed only the lending of moremoney. Stripped of the lure of profit by which

ership, they have resorted to exhortations,pleading tearfully for restored confidence. Theyknow only the rules of a generation of self-seekers, They have no vision, and when thereis no vision the people perish.

To some extent, such a suggestion was accurate;Treasury Secretary Mellon and the liquidation-ists had initially refused even to admit that therewas a problem.

Some proposed that complex intrigues were atwork to sap the nation’s wealth. Rep. Leinke(see the quote referenced in footnote 7), for ex-ample, advanced a monetarist thesis that boththe boom of 1929 and the Depression were theintentional result of Federal Resetve policy.More conspiratorial still was Rep. McFadden’sbelief, advanced on the House floor, that“money Jews” lay behind the banking crisis.”Rep. Weidenian, offering the metaphor that “themost dangerous beasts in the jungle make thesoftest approach,” claimed that “internationalmoney lenders” had duped the Congress intocreating a system for skimming hank goldreserves into a central pool “to feed the maw ofinternational speculation.””

Alarm generated by the crisis and frustrationat the lack of a remedy combined to expand thepolitical horizons. Radical solutions were sug-gested. Informed by the political experimentsunder way elsewhere, relatively sober proposalswere submitted to scrap the inefficient bureau-cracies of representative democracy in favor ofa fascist dictatorship or state socialism.” More

“Love (1932), p. 25.“Before deposit insurance, banks in financial trouble were

generally treated like any other business. Closure mightbe declared by supervisors or the directors of the bank.One option was then to seek protection from depositorsand other creditors by declaring bankruptcy and acceptinga court-appointed receivership. In the case of a temporaryliquidity problem, a bank might instead suspend withdraw-als or close to the public until the problem could beresolved. In practice, the terms “failure” and “suspen-sion” were often used interchangeably. In the period1921-32, roughly 85 percent of failed banks—holding 76percent of the deposits in failed banks—were state banks(including mutual savings banks and private banks). SeeBremer (1935), especially footnote 1 and pp. 41-49.

See Federal Reserve Board (1934a), Colt and Keith(1933) or Friedman and Schwartz (1963) for a chronologyof the banking crisis and the bank holidays. In a sense,Roosevelt had stage-managed the crisis. By refusing toparticipate with the outgoing administration over the bank-ing situation, he prolected the image of making a cleanbreak with the past. At the same time, however, the result-ing uncertainty surrounding his policy toward banking andthe gold standard helped to provoke the crisis. SeeKennedy (1973), pp. 135-55, or Burns (1974), pp. 31-51.

‘4Roosevelt (1938), p. 12.“McFadden lost his House seat over the incident. Scandal-

ized by his comments, the Republican and Democraticparties. both of which had endorsed him in 1932, repudiat-ed him in the 1934 elections. See Martin (1990), p. 249,and Rep. McFadden (R-PA), Congressional Record (1933),pp. 6225-27.

‘“Rep. Weideman (D-Ml), Congressiona/ Record (1933),pp. 3921-22. Weideman, in a conspiracy theory shared bythe radio priest, Fr. Coughlin [see Chernow (1990). pp.381.82], also claimed that the Great War had been or-chestrated by international financiers, noting: “Six monthsafter the Federal Reserve Act was passed the war began.”

“See, for example, Ogg (1932), Calverton (1933) andSchlesinger (1960). Indeed, for many, the New Deal wasstate socialism. One must bear in mind that 1933 predat-ed most of the failures and atrocities of the various Euro-pean dictatorships. Although the collectivization of Sovietagriculture was largely complete, Stalin’s great politicalpurges did not begin until the mid-1930s. Mussolini wasstill widely respected as the man who had brought orderand unity to Italy; the invasion of Abyssinia was not until1935. In Germany, Hitler was only beginning to wrest con-trol from the notoriously ineffectual Weimar republic: hebecame Chancellor in late January 1933, and the Nazisburned the Reichstag four weeks later.“See “What’ll We Use for Money?” (1933).

A Chronology1/10/33 Sen Huey Long’s filibuster of the Glass legi lation begins

1/21/33 Senate filibuster ends.

1/30/33 Hitler becomes Chancellor of Germany

2/20/33 Prohibition repealed

3/4/33 Franklin D Roosex elt is inaugurated 72nd (ongres 2nd ses ion endsSenate of the 73rd Congress convenes tn special session.

3/6/33 President Rooset cIt declares a nation-wide bank holiday las ing nine days.

3/9/33 Congress convenes tn extr ordinary session (first session of the 73rd Congress)The Emergency Banking Act is inti oduced passed and signed in o law.

5’15/33 Carter Gla, mt odu es 5 631

5/17/33 Henry Steagall introduces H II. aGGl

5/19/33 Arthur Vandenberg introduces an amendment to the Glass bill.

5,23/33 House pass~.sSteagail bill.

5/26/33 Senate passes Glass Vandenberg bill

5,2/33 The Securities Act of 1933 signed

6/12/33 World Monetary and Economic Conference opens in London.

6/13/33 Conference committee submits a conference report on the Banking Act to CongressBanking Act of 1933 is approved by Congress

6/16/33 President Roosevelt signs the Banking Act of 1933First session of the 73 d Congress adjourns

9/4/33 ABA Contention begins in Chicago (ends 9/7/33)

9/17/33 ABA President Frank Sisson dies

1/1/34 Federal Deposit Insurance Coi poration is charteredTemporary deposit insurance begins.

popular n as a flirtation with got ernment by Ihe measure of the restoration lie5 in the extent‘technocracy,” a small panel or cabinet of cx- to which we apply sor ial values more nob/e thanports to replace the congressional and executit e mere monetarj profit.’branches. Relative to alternatives such as thesefederal deposit insurance which had failed in Both proponents and opponents of the depositCongress more than 150 times in the preceding goat anty features of the Banking Act took the50 yeais tt as a remarkably moderate option. l8 rhetorical high ground in arguing their point.

indeed, recourse to moi ality in public debaten as widespread. The ‘noble experiment’ with

The mone changers have fled from their high the prohibition of liquor it as still an issue in theseats in the temple of our chilization. We may 1932 election.’°Oratory was laden with biblicalnow restore that temple to the ancient tt’uths. imagery. Sen. ~andenherg (H-MI) referred to

‘85ee FDIC (1951) and Paton (1932) Paton also cites H R 20Prohibition was widely recognized as having failed by this7806, introduced by Rep. Cable (R-OH) on January 15, time- see Kent (1932) p 261. The Eighteenth Amendment1932, and later revised as H R 10201. H. R. 7806 is omit was repealed in 193~ted from the FDIC (1951) digest.

“Roosevelt (1938), p. 12.

56

“B. C. days—which is to say, Before the Crash.

“i A. C. Robinson saw fit to lecture sub-

scribers to the ABA Journal on the “MoralValues of Thrift)” advising bankers of the needfor “an unshake-able conviction of these ideals [truth and morali-ty] and their ultimate triumph. ‘if thou faint inthe day of adversity, thy strength is small.’ “22

For many, the Depression represented anatonement for the excesses of the bull market.By all accounts, 1929 was characterized by stockmarket speculation.23 As the extent of the ava-rice became clear with hindsight, the notion ofeconomic depression as punishment for econom-ic transgression took hold:

We are passing through chastening experiences,as severe for the banker as for anyone else,many of the illusions have disappeared and thetrappings of a meretricious prosperity havebeen stripped from most persons.”

The notion of recession as a necessary purga-tive unfortunately extended to policymakers aswell. Mellon’s advice to Hoover exposes the pi-ous foundations to the liquidationist view of theDepression:

It will purge the rottenness out of the system.High costs of living and high living will comedown. People will work harder, live a moremoral life. Values will he adjusted, and enter-prising people will pick up the wrecks fromless conipetent people.”

‘This fluency with righteousness revealed itselfon all sides of the deposit insurance debate.Both proponents and detractors of the depositguaranty provisions of the Banking Act arguedthat their position was ultimately a matter ofsimple justice, which dare not be denied. Thebankers declared that well-managed banksshould not be forced to subsidize poorly run

banks. Supporters of the legislation maintainedthat depositors should not have to bear the loss-es accruing to their bankers’ mistakes. Thosewho felt that deposit insurance was a ploy todestroy the dual banking system painted a pic-ture of the unit bank as the pillar of the na-tional economy, untainted by corruption. ‘Theremainder of the paper is organized aroundthese three loosely defined constituencies.

[.i1’FITXUL/i.’..IES

Opposition to deposit insurance can be roughlyorganized into two classes: objections on technicalactuarial grounds, and objections to its anticipatedimpact on bank structure. The core constituencyin the former category consisted of the money-center banks, with ABA President Francis Sisson,himself a Wall Street banker, taking the lead.’”The economic motivation for their opposition wasthe belief that insurance meant a net transferfrom big banks, where the bulk of deposits lay, tostate-chartered unit banks, where they expectedthe bulk of the losses.

nsur’a.rp.cc’ arid G;wn’anti’es

In the law as written the guaranty plan isreferred to not as a guaranty of bank deposits,but as an insurance p/an. There is nothing in thisplan that entitles it to be classed as insurance.”

1 think you gentlemen are all wrong to call this aguarantee of deposits. There is not a thing in thebill that talks about guarantee. It is an insuranceof deposits.”

The actuarial correctness of the term “depositinsurance” as a description of the proposed legis-lation was a point of contention. The alternativelabel, offered by opponents, was “deposit guaran-ty.” One’s choice of terms usually revealed where

2’Vandenberg (1933): p. 39.‘2Robinson (1931), p. 209.23”Orgy of speculation” was the catch phrase that captured

the popular sentiment. For example, “Our Orgy of Specu-lation” (1929), p. 907, quotes Chancellor of the ExchequerPhilip Snowden: “There has been a perfect orgy of specu-lation in New York during the last twelve months?’

‘“Robinson (1931), p. 209.“Hoover, quoted in De Long (1990), p. 5. Bankers Magazine

offered it as a modern paradox, “that depressions aresent by heaven for the chastening of mankind?’ See“Modern Paradoxes” (1933). The liquidationists drew asardonic retort from Keynes, who identified it as sanctimonymasquerading as economics: “It would, they feel, be avictory for the mammon of unrighteousness if so muchprosperity was not subsequently balanced by universalbankruptcy.” See Keynes (1973), p. 349.

Mellon’s advice also offers an example of a commontendency to anthropomorphize the economy, in this caseas a system to be purged. For a more extreme example,see Taussig (1932), who draws an elaborate analogy be-tween physicians and economists.

‘“The ABA (1933a) dissected the failure of the various stateinsurance schemes. The Association of Reserve CityBankers (1933) published a monograph late in the debateoutlining the actuarial objections to deposit insurance.

27Association of Reserve City Bankers (1933), p. 27.28

C. F. Dabelstein, in ABA (1933b), p. 58. For similar re-marks, see Rep. Beedy (R-ME), Congressional Record(1933), p. 3911; Sen. Glass (D-VA), ibid., p. 3726-27; andDonald Despain, quoted by Sen. Schall (R-MN), ibid.,p. 4632.

one stood on the issue, and the semantic con-troversy became a microcosm of the actuarialissues involved.” By labeling the various schemesas plans to “guaranty” deposits, opponents wereable to associate the plans immediately with theinfelicitous recent experience with state depositguaranty schemes (discussed in the next subsec-tion). The natural response for supporters wasto insist on a different label.

Both proponents and opponents devoted ener-gy to identifying the desirable “insurance princi-ple,” which then either accurately described orfailed to describe the proposed legislation.’” Likeblind men describing an elephant, however, fewagreed on a definition for the insurance princi-ple. This was so, despite Rep. Steagall’s claimthat the principle of insurance was “the mostuniversally accepted principle known to thebusiness life of the world.”

Deposit insurance was clearly similar in manyrespects to other types of insurance, which hadbeen in vvidespread use in the United States fordecades. Even the most ardent detractor recog-nized some resemblance:

The general argument employed to promrne theguaranty plan began with the premises thatproperty can be insured and bank deposits areproperty. It travelled to the broad assumptionsthat the principle of the distribution of riskthrough insurance could he applied to bankdeposits.”

The salient principles here, espoused repeatedlyby supporters of the legislation, were the diver-sification of risk and the diffusion of losses. in

this respect, a national plan would differ fromthe state plans, which had “violated the primaryinsurance tenet that risks must be decentralizedand sufficiently spread so as to avoid concen-trated losses.”

For others, the distinction between govern-ment and private backing defined the differencebetiveen insurance and guaranty. Both Sen.Glass and Rep. Steagall were adamant that cov-erage be provided privately, not by the

government:

This is not a Government guaranty of deposits.The Government is only involved in an initialsubscription to the capital of a corporationthat we think will pay a dividend to the Gov-ernment on its investmenL It is not a Govern-ment guaranty.”

I do not mean to he understood as favoringGovernment guaranty of bank deposits. 1 donot. I have never favored such a plan. -

Bankers should insure their own deposits.”

‘I’he argument against government backing wasoutlined by Sen. Bulkley.’”

An insurance feature included in both theSteagall and Glass bills and in Sen. Vandenberg’stemporary insurance amendment to the Glassbill was a provision for depositor co-insurance.”The Glass and Steagall bills called for a progres-sive depositor copayment schedule: the first$10,000 would be covered in full, the next$40,000 would be covered at 75 percent, andonly 50 percent of amounts over $50,000 wouldbe covered; the Vandenberg amendment set asingle coverage ceiling at $2,500. Some propo-

‘“The FDIC (1951), p. 69, provides a clear distinction be-tween insurance and guaranty. By their definition, aguaranty is a promise from the U. S. government to payoff depositors in a failed bank; insurance is paid from anindependent private fund. There was no agreed definitionfor insurance or guaranty in 1933, however, although theexplicit acknowledgement that “no clear distinction [be-tween the terms ‘guaranty’ and ‘insurance] has beenmade,” was rare; see Rep. Bacon (R-NY). Congress/ona/Record (1933), p. 3959. W. B. Hughes also attempted toextricate the “inexcusable mixture of the two termsGuarantee is where you make the good bank pay for thepoor one. Insurance is where you make those who get thebenefit pay for it?’ See ABA (1933b) p. 59. I use the twoterms interchangeably in this article.

“In fact there were numerous conflicting legislativeproposals afoot. That of Henry Steagall, who chaired theHouse Banking Committee, was taken most seriously; iteventually became law. See FDIC (1951) and Paton (1932).

“Congressional Record (1933), p. 3836.“ABA (1933a), p. 7.“Sen. Vandenberg, Congressiona/ Record (1933), p. 4239.

“Sen. Glass, Congressional Record (1933), p. 3729. Seealso footnote 28.

“Rep. Steagall, Congressional Record (1933), p. 3838.‘“See the quote referenced by footnote 1. Similar concerns

were voiced by Jamison (1933), p. 451: “The great urgen-cy for balancing the national budget precludes even thethought of piling another subsidy on the shoulders of thealready overburdened taxpayers.”

These sentiments are especially noteworthy in light ofrecent attempts to paint the insurance schemes as havingtaxpayer backing from the start. For example, Title IX ofthe Competitive Equality Banking Act of 1987 states thatCongress “should reaffirm that deposits up to the statutori-ly prescribed amount in federally insured depository insti-tutions are backed by the full faith and credit of theUnited States;” (emphasis added).

“Co-insurance is the insurance practice of involving the in-sured party in some portion of the risk. Common tech-niques of co-insurance are coverage ceilings, deductiblesand copayment percentages. The aim of such provisionsis to mitigate the problem of moral hazard or the tendencyof people to behave more riskily when insured.

JtJt,Y/A’,JCjLiST 1992

nents saw no need for such mitigating features.Rep. Dingell (D-MI), for example, offered bankersno quarter; his idea was “to guarantee everydollar put in by the depositor from now on andto make the banker and the borrower pay thecost.” For Sen. Vandenberg, on the other hand,co-insurance was crucial; he complained angrilywhen Treasury Secretary Woodin proposed “nota limited insurance such as is included in theamendment which the Senate adopted, but acomplete 100% guarantee.”

Opponents in the banking industry were un-impressed by such arguments. Although all ofthe proposals achieved a spreading of losses andmany had other familiar features of insurance,such as co-insurance or provision for a largereserve fund, they still were not “insurance.”Francis Sisson was obstinate: “Detailed and tech-nical differences in this bill as compared withformer guaranty schemes do not differentiate itin essential principle from them “41 For all theirtrouble, crafters of the legislation had failed tomeet the bankers’ standard for insurance, theprinciple of selected risks:

Insurance involves an old and tried principle.The essence of insurance is the payment by theinsured of premiums in actt,arial relation to therisk involved. Under the terms of the perma-nent plan, however, the costs or premiums arenot charged according to the risk.~’

Roosevelt made a similar connection. In his firstpresidential press conference, he asserted:

I can tell you as to guaranteeing bank depositsmy own views, and I think those of the old Ad-ministration. The general underlying thoughtbehind the use of the word ‘guarantee’ withrespect to bank deposits is that you guaranteebad banks as well as good banks. The minutethe Government starts to do that the Govern-ment runs into a probable loss.~’

Although he associates the “guaranty” terminol-ogy with government backing, its defining char-acteristic is clearly the absence of selected risks.

Despite the attention given to selected risks inthe debate, no significant attempt appears tohave been made to include a risk-based premi-um in legislation. Emerson, for one, thoughtsuch an arrangement could work.’” The ABA,on the other hand, thought it impossible:

The apparently unsurmountable actuarialdifficulty in the guaranty plan appears to bethe impossibility of placing it on the basis ofselected risks;

the risks involved were “wholly unpredictable,”and banks were subject to “internal deteriora-tion” when their deposits were guaranteed.”

ills! rrrr’ a.nd Gr.rrzauisv

As to the history of the guaranty plan, a wa-ce ofguaranty of state bank deposits laws swept overthe seven contiguous western states of Oklahoma,Kansas, Tecas, Nebraska, Mississippi, SouthDakota and North Dakota and the Pacific Coaststate of Washington in the period 1908-1 7.The laws establishing it were repealed or allowed

“Congress/onal Record (1933), p. 489. More thoughtful com-mentators realized that the incidence of the cost could notbe contained. Rep. Kloeb (D-OH), ibid., p. 489, challengedRep. Dingell immediately: “Assuming that an assessmentis made upon the bankers, how are we going to preventthat from sifting down to the depositors?” Similarly, Jami-son (1933), p. 454, explained that, “while the banks wouldremit the premiums;’ they would also adjust their interestrates, so that, “in the end the banks’ customers would paythe premiums?’

“Quoted in “Congress Passes and President RooseveltSigns Glass-Steagall Bank Bill as Agreed on in Confer-ence” (1933), p. 4193. The proposal itself is surprising,given Woodin’s strong oblections to deposit insurance.Many others shared Vandenberg’s view; see, for example,Sen. Glass, Congressiona/ Record (1933), p. 3728; Sen.Bulkley (quoted by Sen. Murphy), ibid., p. 3007.

“‘There was disagreement about the reserve fund even af-ter the legislation had been signed. The Association ofReserve City Bankers (1933), p. 28, asserted baldly that“no provision is made for building up a reserve fund aswould be the case under a true insurance plan;’ whileSen. Vandenberg (1933), p. 39, contended that the planwas “capitalized with truly prodigal reserves” (any irony inhis use of the adjective “prodigal” is doubtless unintend-ed). The discrepancy lies in the fact that, unlike Van-

denberg, the Association of Reserve City Bankers did nottreat the FDIC’s capital as an insurance reserve fund.

“Sisson (1933b), p. 31.“Association of Reserve City Bankers (1933), p. 27, (empha-

sis in the original). “Selecting risks” refers to the practiceof differentiating insured parties according to risk andcharging insurance premia according to those risk class-es. For example, 17-year-old men on average pose a great-er risk to auto insurers than do 30-year-old men; therefore,17-year-olds usually pay higher auto insurance premia.

“Roosevelt (1938), p. 37.““Emerson (1934), p. 244, states, “To put such a provision

[assessments levied according to risk] into effect would re-quire the classification of the banks of the country accord-ing to various standards: geographical location, size, type,and character of banking policy. The last would presentadministrative difficulties, but these would not be insuper-able?’ Bankers Magazine had also thought it feasible:“Presumably, an insurance company could be formedwhich by carefully selecting its risks, might operate suc-cessfully?’ See “Protecting Bank Depositors” (1931), p. 435.

“‘ABA (1933a), pp. 42-43. Similarly, Jamison (1933), p. 454,argued that selection of risks in this context would present“complications that can not be easily overcome.”

to become inoperative as one after another of theplans became financially insolvent and was recog-nized as serving to make banking mattersworse.

4”

As in the case of branch banking, Nation-widediversification of insurance risks would securebanking against any eventuality except such a tma-tional calamity as would destroy the Governmentitself.”

The “guaranty” terminology connoted thedefunct state deposit guaranty plans, a specterthat terrorized the bankers. The mere mentionof deposit guaranties could induce a banker toshow “every sign of incipient apoplexy.””’ At thesame time, the unvarying failure of the stateplans provided a trove of evidence for foes ofthe federal scheme.” Release of the ABA reportcoincided with the introduction of the Glass andSteagall bills in Congress. It found perversedelight in the failure of all eight of the stateplans:

Eight large scale tests, by practical working ex-perience, of the guaranty of bank deposits planas a means for strengthening banking condi-tions and safeguarding the public interest are amatter of record. Each one of these attemptsfailed of its purpose.

Taken separately, special circumstances suchas technical defects in the plan or faulty ad-ministration might be held accountable for thebreakdown in any given instance, leaving it anopen question as to whether the idea might notbe successful under different circumstances.Taken as a composite whole, however, thefailures of the various plans not only confirmone another in their defects, but each one also

supplies added special features that were testedand found wanting.’”

This unbroken string of failures demanded anexplanation from supporters of federal legisla-tion. Proponents chose to distinguish clearly thene%v plan from the state schemes: “there is nological relationship between these old StateGuarantees and this new Federal Insurance; noanalogy; no parallel; and no reason to confusethe mortality of the former with the vitality ofthe latter.”

To make this case, supporters emphasizedforemost the much broader geographic—andtherefore industrial—diversification of a federalinsurance fund. “The fact that bank-deposit-guaranty projects have failed in local, restrictedareas only proves one of the fundamental prin-ciples of insurance, that is, that there must existwide and general distribution and diversifica-tion” In particular, the old plans were said tohave suffered from a “one-crop” problem, thatis, their application in states overwhelmingly de-pendent upon agriculture:

There is a vast difference between what can beaccomplished by a small number of banks inone State dependent upon a single crop andwhat can be successfully accomplished by thebanking system of this great Nation that holdsthe financial leadership of the world in itshands.”

On this point, at least, the bankers were forcedto concede.”

The bankers revealed the geographic breadthof the federal plan to be a two-edged sword,

‘“ABA (1933a), p. 7. The seven states listed are not, in fact,contiguous.

“Rep. Bacon, Congress/ona/ Record (1933), p. 3959.“‘Stephenson (1934), p. 35. There is a hint of truth in

Stephenson’s hyperbole. Francis Sisson died of heartfailure within a fortnight of the ABA convention of Septem-ber 1933 — which had included excoriating harangues[see Bell (1934)] delivered by Jesse Jones of the Recon-struction Finance Corporation and soon-to-be FDIC boardmember J. F T. O’Connor; see “Death of Francis H. Sis-son, Vice-President Guaranty Trust Co. of New York andFormer President American Bankers Association” (1933),and O’Connor (1933). In a tribute at the next convention,Sisson’s ABA colleagues offered that his death was “atragic demonstration of devotion to duty even to the extentof exceeding the physical power of endurance ... He wasa martyr to his work in your behalf?’ Nahm (1934), p. 30.

‘“5everal groups dissected the state plans in the course ofthe debate; see American Savings, Building and Loan In-stitute (1933), ABA (1933a), Blocker (1929), Boeckel (1932),and the Association of Reserve City Bankers (1933). Refer-ence was also made to an earlier essay by Robb (1921).

There are also numerous retrospective accounts of thestate guaranty plans, including Calomiris (1989 and 1990),Wheelock (1992b and 1992c), and Wheelock and Kumb-haker (1991); the most comprehensive, however, is Warbur-ton (1959), parts ot which appear in FDIC (1953 and 1957).The original legislation is collected in Federal ReserveBoard (1925a and 1925b).

“ABA (1933a), p. 7.

“Vandenberg (1933), p. 39, (emphasis in the original).

“Donald Despain, quoted by Sen. Schall, CongressionalRecord (1933), pp. 4631-32. Virtually identical argumentsare offered by Vandenberg (1933), p. 39, and Rep. Bacon,Congressional Record (1933), p. 3959.

“Rep. Steagall, Congressional Record (1933), p. 3838.

““For example, the Association of Reserve City Bankers(1933), pp. 31-32, acknowledged that, “It is suggestedthat a single crop failure could shake the stability of allthe banks in a State. On a national scale the plan wouldoperate upon a broader base. This is true.”

Table 1Estimated Assessments and Losses by Geographic Division

Percent of assessments in Percent of losses in eacheach division to division during 1921-1931

Geographic division total assessment to total losses

New England 7.6% 37%Middle Atlantic 440 200North Central 186 21 9Southern Mountain as saSoutheastern 2.8 137Southwestern 43 7.0Western Grain 80 207Rocky Mountain 18 45Pacific Coast 27

United States 1000% 100.0%

however, and used it to fight back. They cx- and the conservative banker pays the fiddler. Ifploited the well-known fact that bank failures the conservative banker protest., the slack onethroughout the 1920s had occurred dispropor- invites him to go to a warmer climate. Soon alltionately among small, rural banks (see table are dancing and the fiddler, if paid at all, must1).” This information was used to argue that, collectfrom the depositors or from the taxpayers.’”with insurance premia assessed against deposits, For those who opposed deposit insurance onthe burden of funding federal deposit insur- actuarial grounds, such technicalities wereance—had it existed during the 1920s—would merely manifestations of a more fundamental is-have been borne in large measure by the money sue. As a matter of principle, deposit insurancecenter banks of the Northeast, where much of was held to be unjust. It involved the forcedthe industry’s deposit base lay. i’he benefits of subsidization of poorly managed banks by wellinsurance, however—the payments to cover managed institutions; it subsidized the “bad”losses in failed banks—would have gone south banker at the expense of the “good.” This moraland west. point provided substantial emotional force. op-

ponents concluded that only good bank manage-ment could ultimately assure safe and sound

banking.~7 ,~

Their argument, founded in actuarial theoryFor it is to be remembered that the weak banks and the experience of the state plans, proceededget the same insurance as the strong ones, and, - . - -

- in two steps. First, by protecting depositorsunhke the situation in other kinds of insurance,the bad risk pays no more for its insurance than against loss, a deposit guaranty would destroythe good one. This means competition among discipline; insured depositors would take no in-banks in slackness in the granting of loans. The terest in the quality of their bank’s manage-bank with the loose credit policy gets the busi- ment. Recalling the state plans, the guarantyness and the hank with the careful, cautious had created “a sense of false security and lackcredit policy loses it. The slack banker dances of discrimination as between good and bad

“The table is reproduced from Association of Reserve City ment guaranty of bank deposits can be but one of twoBankers (1933), p. 26. See Bremer (1935) and Upham and things — an outright subsidy ... or a plan of insurance?’Lamke (1934) for analyses of failures in the 1920s. Bradford (1933), p. 538, added: “Such subsidization of

‘“E. W. Kemmerer of Princeton University, speaking to the weak banks by the Government, however, carried out onSavings Bank Association of Massachusetts on September the basis of taxpayers money, is so monstrous as to be14, 1933, and quoted in Association of Reserve City almost unthinkable.Bankers (1933), pp. 40-41. Kemmerer was the economicadvisor to the comission that produced the latter. Similarthoughts were offered by Jamison (1933), p. 451: “Govern-

Ful

money swallowed upin the greatestbear market of all “imes, the bankslost every peony.

The ssark reality of these facts de-mand eternal vigilance in grantingevery loan. Particularly in grantingcommercial loans, make sure thatyour borrowers are adequately cov-ered by Fidelity Bond,. You alwaysinsist that your borrowers carry fireinsuranceeo safeguardtheirphysicalassets. Ask for the same protectionagainst the possible peculationsof their employees. insist ehar yourloans be protected against the frail-ties of humae cites-c. For an em-ployee, as well as a fire, can wrecka firm.

FIDELITY & DEPOSITCOMPANY OF MARYLAND55,,,,, 0th,,’ 55dslia,d

S,,s,y SacS,

ea,5,,,,ed 5],,,

banking.”a7 In many minds, this dichotomy be-tween good and bad bankers was the central is-sue.58

Bankers Magazine editorialized that “thesurest ieliance of good banking is to he foundin the men who manage the banks rather thanin the laws governing their operations.”” In1931, ABA President Rome Stephenson contended

that, a large element in the internal conditionsof the banks that failed was bad management

and that a predominant element in the internalconditions of the hank that remained sound inthe fare of the same external conditions wasgood management.~”

What was needed was to teach “the conceptionof scientific banking.”6’

The second step in the logic of opposition wasan objection to the subsidy implicit in a guar-anty. In the tones of a prudish parent, the ABAcomplained that the beneficiaries of state sys-tems had been the “bankers with easier stan-dards,” who gained competitive advantages overthose with “sounder but less attractive meth-ods.””~The subsidy was especially problematicamong those banks “which have little chance ofultimate success.””’

A bank which does not earn a fair average rateof return over a period of years not only is un-able to build up reserves against had times, hut,in order to improve profits, is under constanttemptation to take risks ‘vhich in the end arelikely to lead to failure.

The tendency of a guaranty plan will he tonurtut-e these unprofitable units and keep themgoing temporarily in the knowledge that uponfailure the losses can be shifted to other banks.e4

Thus, the subsidy was seen to extend beyond

the simple protection of unsound institutionsfrom the competitive pressures of vigilant depos-itors. Given their contention that, “no provisionis made for building up a reserve fund,” losses

charged to the insurer by failing banks wouldhave to he recouped after the fact from the sur-vivors.° Such a system would necessarily entail

transfers of wealth from surviving to failedbanks.

There was no consensus in Congress on theimportance of discipline; some members pointedout that life insurance was no incentive for sui-cide.56 The framers of the Glass and Steagallbills, however, recognized the validity of thehankers’ objections and addressed the issuedirectly. Both hills, as well as the temporary in-

“ABA (1933a). p. 13.“The advertisement above depicts an insurer’s characteri-

zation of the bad banker. Coincidentally, PresidentRoosevelt had been a vice-president for the Fidelity andDeposit Co. of Maryland after his unsuccessful Vice-Presidential bid in the 1920 election.

““Federal Guaranty of Bank Deposits” (1932), p. 381.“°Stephenson(1931), p. 592.55Ibid., p. 592.52ABA (1933a), p. 25. More specifically, “greater numbers

than ever of undercapitalized, ill-situated banks, as well asof persons wholly unfitted as to training, character or

methods to be allowed to conduct banks, were able tocommand public trust and patronage and to attract largedeposits to their institutions through high interest ratesand trading on faith in the guaranty plan?’ ABA (1933a), p.17.

“‘Association of Reserve City Bankers (1933), p. 29.““Ibid., pp. 19-20.“‘Ibid., p. 28.“See, for example, Rep. Luce (R-MA), Congress/ona/

Record (1933), p. 3918. Sens. King (D-UT) and Glass brie-fly debated the role of immortality in the context of thisanalogy; Congressional Record (1933), p. 3728.

HERE RESTS ~493,OOOWORTH OF REGRETS

IT happened this way. He was thecomptroller of a large corpora-

tion in New York City—a directorofhis local suburban bank— a fondfather—he hadthe esteemoffriendsand business associates alike. To-day he is serving from three and ahalf to ten years for defrauding fivebanks and three brokerage houaeaof $493,000.00.

Wall street proved his Waterloo.Naturally interested in market move-ments,his interestled him graduallyinto heavy speculation. As the mar-ket went down so did he—deeperand deeper. Finally, desperate, heforged stock certificates of his owncompanywhich heuaed as collateralto bolster his personal brokerageaccounts.

Then, one day the axe fell. A check-up revealed that he had defraudedfive banks sod three brokeragehouses on, of $493,000. With the

surance amendment in the Senate, were carefulto limit coverage. Sen. Vandenberg stated ex-plicitly the rationale for coverage ceilings:

the State Guarantees involved complete protec-tion for all banking tesources Federal Insur-ance, on the other hand, leaves the individualbank and banker so seriously responsible forsuch a preponderance of their resources thatthere is no appreciable immunity at all.”~

Sen. Glass noted a second source of disciplineinherent in the plan. Because the banks insuredeach other, deposit insurance would “lead to theseverest espionage upon the rotten banks of thiscountry that we have ever had.””5

Under both the temporary and permanentplans, the small depositor was to be covered infull, in recognition of his inability to monitorbank management adequately:

At present the depositor is at the mercy of hisfellow depositors, over whom he has no con-trol, and of the management of the bank, aboutwhich he is not usually in a position to be wellinformed. The depositor takes the risks, andthe banks take the profits.”

A survey conducted by the Comptroller of theCurrency and the Federal Reserve in May 1933revealed that the ceiling of $2,500 under thetemporary plan would fully cover 96.5 percentof depositors and 23.7 percent of total depositsin member banks.’°

r’ij’s~c;i;tj~.:i..~i:~sI1’t~

While most industry opponents fought thedeposit insurance plan on actuarial grounds,supporters argued that deposits per se requiredprotection, to stabilize the medium of exchangeand promote a renewed expansion of bankcredit. More significantly, proponents responded

with an argument of powerful simplicity: thelosses to innocent depositors in a bank failurewere a plain injustice. Given the status of banksin the political climate of 1933, this was a chargethat the bankers ultimately could not counter.

— ,, ft

The use of banking funds for speculation becamea stench in the nostrils of the people.”

There was a strong sense that the banking in-dustry in the 1920s had functioned as an elabo-rate network to collect savings at the local leveland funnel them into lending on securitiesspeculation:

Another cause for many banking collapses wasthe domination of smaller banks by their largemetropolitan correspondents, which drainedfunds from the country districts for speculativepurposes and loaded up the small bank withworthless securities.”2

Indeed, this was a primary motivation for thosesections of the Banking Act requiring a separa-tion of commercial and investment banking.Similar arguments were brought against pro-posals for nationwide branch, chain and groupbanking.”

A sensitivity to such a possibility was doubt-less nurtured by the popularity of Ponzi schemesin the 1920s, including the infamous Floridaland swindIes.”~With such analogies in mind,banks came to be seen as

merely fueling departments in enterprises runnot by bankers concerned with operating banksbut by promoters whose object was to exploitthe credit resources of the bank.

67Vandenberg (1933), p. 39, (emphasis in the original).“Sen. Glass, Congressional Record (1933), p. 3728.“Rep. Bacon, Congressional Record (1933), p. 3959.“See Federal Reserve Board (1933c), p. 414. The point to

be made was that even the temporary plan succeeded infully covering the vast majority of depositors. The survey,of course, took place before depositors had an incentive tosplit larger deposits into multiple accounts to achieve fulldeposit insurance coverage.

“‘Rep. Luce, Congressional Record (1933), p. 3914.“2Rep. Bacon, Congress/onal Record (1933), p. 3952. Comp-

troller Pole was instrumental in dichotomizing the industryinto “two definite types of banking, namely, that carriedon by the small country bank and that of the large citybank.” See “Comptroller Pole’s Views on Rural Unit Bank-ing,’ (1930), p. 468.

“Group banking and chain banking are essentially variantsof the modern bank holding company form of organiza-tion. Group banking presumed some degree of standardi-zation among the subsidiary banks in the holdingcompany, while chain banks were operated as largely in-dependent franchises within the holding company.

““A Ponzi scheme is a fraudulent investment plan, such asa chain letter, in which returns to existing investors arepaid directly from the deposits of new investors, with thedirector of the scheme skimming the difference. Some ofthe Ponzi schemes had been run by Charles Ponzi him-self. After several jail terms and a stint on the lam, Ponziwas finally deported to his native Italy in 1934. This wasnot his first one-way ticket. In 1903, his family had boughthim a one-way ticket to Boston on the S. S. Vancouver ina successful bid to get rid of him. See Grodsky (1990).

63

The primary evil in our banks for many yearshas been the incessant efforts of promoters toget control of the funds which flow into thebanks. The bank is the depository of the com-munity’s funds and as such is the basis of theavailable credit of the community. The promoter-banker needs nothing so much as access tothese credit pools.”

Such accusations were inevitably tinged with atleast a hint of the conspiratorial.””

In keeping with this theme, the issues wereframed for popular consumption as a moralityplay in which the naive depositor is pitted againstthe sophisticated banker. The depositor tucksaway the hard-earned wages of his honest labor,only to be systematically duped by the cunningintrigues of the banker. At the extreme, somepoliticians played the religious card face up:“We discovered that what we believed to be abank system was in fact a respectable racketand so many connected with it only cheap, pettyloan sharks and Shylocks.” In the end, a provi-dential government was seen to intercede onbehalf of the depositor, and deposit insurancewas trumpeted as “the shadow of a great rockin a weary land”8

The notion of the small depositor as an inno-cent victim had immense popular appeal.McCutcheon’s 1931 political cartoon celebratingthe blamelessness of the depositor in a failedbank won the Pulitzer Prize (above right). Suchpopularity, of course, was plainly evident topoliticians, who responded by introducingdeposit insurance legislation in Congress. Rep.Steagall is reported to have told House SpeakerGarner in April 1932, “You know, this fellowHoover is going to wake up one day soon andcome in here with a message recommendingguarantee of bank deposits, and as sure as hedoes, he’ll be re-elected.”~

selves with the legislation. Sen. Vandenberg, upfor re-election in 1934, was always careful tocall his temporary insurance amendment to theBanking Act of 1933 “The Vandenberg Amend-ment.” Rep. Dingell announced: “guaranty ofbank deposits is my baby in Michigan.”5°A peti-tion circulated in the House in June 1933 topostpone adjournment indefinitely until a de-posit insurance bill was made law.”’ Figure 1

“Flynn (1934), pp. 394-96.“Rep. Steagall, for example, avowed that a “campaign was

turned on urging bankers everywhere to ... employ theirfacilities in investment banking, in speculation, in stockgambling, and in aid of wild and reckless internationalhigh finance.” Congressional Record (1933), p. 3835. TheSeventy-first Congress had formed a Senate Banking andCurrency Subcommittee to investigate the extent to whichthe Federal Reserve and National Banking systems hadbeen co-opted to “finance the carrying of speculativesecurities.” Sen. Bulkley, quoted by Sen. Murphy, Con-gressional Record (1933), p. 3006. See also footnotes ISand 16 an the related text.

“Rep. Dingell, Congressional Record (1933), p. 3906.‘“Rep. Hill (D-AL), Congress/ona/ Record (1933), p. 5899.

Hill’s pronouncement was met with a round of applause inthe House.

‘“Timmons (1948), p. 179. Garner responded, ‘You’re rightas rain, Henry, so get to work in a hurry. Report out adeposit insurance bill and we’ll shove it through:’ Theresult was H. R. 11362, which passed the House onMay 27, 1932.

“Rep. Dingell, Congressional Record (1933), p. 3906. It isnoteworthy that both Sen. Vandenberg and Rep. Dingellwere from Michigan, where, on February 14, 1933, WilliamA. Comstock had become the first governor to declare astate banking holiday during the crisis; see Colt and Keith(1933), pp. 6-8. In light of the temporary insurance amend-ment, any dispassionate observer would have to regarddeposit insurance as Vandenberg’s baby in Michigan.

“15ee H. Preston (1933), p. 589, and Rep. McLeod (R-MI),Congressional Record (1933), p. 5825.

Rapa,’~ay peetes,,: 8e,,, Maaa ass,,,

For obvious reasons, bank failures concentrat-ed the attention of large numbers of voters, andCongressmen were anxious to associate them-

a “92

It is much more important in principle toguarantee bank deposits, because the real cir-culating medium of the country is bankdeposits.”’

Although, as a strictly political matter, deposi-tor protection was the central motivationresponsible for the progress of deposit insur-ance in Congress, other forces were at issue.Chief among these was the role of banking inthe real economy. Regarding bank failures, itwas recognized that causality ran two ways:just as the general drop in real incomes hadcaused loan defaults and thus widespread bankfailures, bank failures and the concomitant re-striction of bank services had caused real in-comes to fall. The latter effect was seen tooperate both directly and indirectly.

Bank suspensions and failures could trapdepositors’ wealth for a period of months oreven years until the bank either reopened or itsbankruptcy was resolved. The direct result wasreduced consumption and investment spendingby the affected depositors. In the extreme case,when a town’s lone bank failed, even the sim-plest forms of exchange could be hopelessly en-cumbered:

[The unacceptability of failurel would perhapsnot be so if they were grocery stores or butch-er shops, where failure would be disastrous toonly a few people at most; but bank failuresparalyze the economic life of whole communi-ties, not only through the loss of money ac-cumulations but by the destruction of thedeposit currency which is the principal mediumof exchange in all business activity.”’”

Under such circumstances, some affected re-gions instituted scrip currencies, wooden coinageor systematic barter arrangements, the mostelaborate of which was the Emergency Ex-change Association in New York, headed byLeland Olds.’””

A depositor’s natural response to these possi-bilities was to withdraw his funds before failure

occurred. Both bank runs and the hoarding ofcurrency received considerable attention.”°Withdrawals for the purpose of safeguardingone’s wealth were deemed unpatriotic; legisla-tion was even proposed to outlaw the practice.Banks had a natural response to the threat ofruns: “Credit was tightened in the desire to re-main as liquid as possible to meet the emergen-cies of runs.”” Bankers maintained large cashreserves rather than lend:

it is estimated that banks now have availablebillions of dollars of collateral for use in extend-ing loans, but the plain fact is that for morethan 3 years bankers have given little thoughtto anything except to keep their banks in liquidcondition The fear that grips the minds andhearts of bankers, keeping ever before themthe nightmare of bank runs, makes it impossi-ble for them to extend the credits that are in-dispensable to trade and commerce.’2

This analysis is confirmed by the facts. The ag-gregate excess reserves of Federal Reserve mem-ber banks, for example, had ballooned from $42million in October 1929 to a peak of $584 mil-lion in January 1933, even though the numberof member banks had fallen from 8,616 to6,816 over roughly the same period.”’ Thus,bank failures were seen to have an indirect ef-fect on output, as both depositors and bankersin solvent institutions prepared for the possibili-ty of runs and failures.

In the final analysis, depositor protection andstabilization of the medium of exchange wererecognized as opposite sides of the same coin:

We may talk about percentage of gold back ofour currency, we may discuss technical provi-sions of legislation ... The public does not un-derstand these technical discussions, but fromone end of this land to the other the people un-derstand what we mean by guaranty of bankdeposits; and they demand of you and me thatwe provide a banking system worthy of thisgreat Nation and banks in which citizens mayplace the fruits of their toil and know that a

“‘Fisher (1932), p. 143.““Greer (1933b), p. 538.““See “What’ll We Use for Money?” (1933).““See lves (1931) for colorful accounts of depositor runs and

the various responses of bankers. Rep. Bacon, Congres-sional Record (1933), p. 3959, estimated hoarding at $1.5billion in January 1933. The extent of hoarding was alsoroughly gauged by tracking deposits in the U. S. PostalSavings system. Such deposits roughly quadrupled in thetwo years ending June 30, 1933 [see O’Connor (1933). p.231. Fr~edmanand Schwartz (1963), p. 173, state that such

deposits remained a “minor factor” in spite of theirgrowth. The system was established by the Postal SavingsBill of 1910 and was intended primarily for the savings ofnew immigrants. Deposits were guarantied in full. Vice-President-elect Garner reportedly told Roosevelt, “You’llhave to have it [deposit insurance], Cap’n, or get moreclerks in the Postal Savings banks1 See Timmons (1948),p. 179.

“‘Rep. Bacon. Congressional Record (1933), p. 3959.“2Rep. Steagall, Congressiona/ Record (1933), p. 3840.

“‘Federal Reserve Board (1943), pp. 72-74, 371.

deposit slip in return for their hard earningswill be as safe as a Government bond. [Ap-plause.]

They know that banks cannot serve the pub-lic until confidence is restored, until the publicis willing to take money now in hiding andreturn it to the banks as a basis for the expan-sion of bank credit. This is indispensable to thesupport of business and the successful financ-ing of the Treasury. It will bring increasedearnings, higher incomes, and make it possibleto balance the Government’s Budget withoutresort to vicious and vexatious methods of taxa-tion.’”

As such, they should be considered inseparable;it is clear that supporters of the legislation in-tended it to achieve both ends. Attempts to rankthe two issues according to their- relative im-portance are likely to be inconclusive.”’

One banker in my state attempted to marry awhite woman and they lynched him.””

The opposition to federal deposit guarantiesemanated largely from the nation’s bankers.This fact was a crushing liability to their causein the political climate of 1933. The introductionof the Glass and Steagall bills came on the heelsof the banking panic and, not entirely coin-cidentally, amid the daily revelations of self-dealing and other cupidities from the Pecorahearings.”’ The banker had become a pariah.

““Rep. Steagall, Congressional Record (1933), p. 3840.“5Golembe (1960) has argued that, among the motives for

deposit insurance, depositor protection was secondary toprotection of the circulating medium. Others have gonefurther, arguing that protection of depositors was a ration-alization created after the fact. The issue raised byGolembe is certainly plausible; Rep. Bacon, for example,appears to have ranked them this way [CongressionalRecord (1933), p. 3959]. On the other hand, it is notewor-thy that Sen. Glass in 1933 abandoned his earlier plan fora liquidation fund, which would have prevented the freez-ing of funds in suspended banks white still not protectingdepositors from loss. The latter notion of depositor protec-tion as an ex-post or revisionist justification is clearlyfalse, however.

““This was a popular quip that made the rounds in 1933. Inthis instance, it is attributed to Carter Glass; see Kennedy(1973), p. 133; Bell (1934), pp. 262-63, also cites it. Theloke is startling in its insensitivity. Examples of bankers ofthe day indulging in overtly racist humor are also availa-ble; see, for example, Dyer (1933), pp. 91 and 94, and Am-berg (1935), p. 49.

‘“‘The hearings were organized in January 1933 by theSenate Committee on Banking and Currency, and wererun by the Committee’s counsel, Ferdinand Pecora; seePecora (1939). The dust jacket relates that, in one in-

Roosevelt fired the opening volley for his ad-ministration in his inaugural address:

Plenty is at our doorstep, hut a generous use ofit languishes in the very sight of the supply.Primarily this is because the rulers of the ex-change of mankind’s goods have failed, throughtheir own stubbornness and their own in-competence, have admitted their failure, andabdicated. Practices of the unscrupulous moneychangers stand indicted in the court of publicopinion, rejected by the hearts and minds ofmen.””

He went on to demand safeguards against the“evils of the old order”: strict supervision of

banking, an end to speculation with “other peo-ple’s money,” and provision for an adequate butsound currency.””

Others were happy to follow this lead. it wascommonplace to hold the bankers, and particu-larly their “speculative orgy” of 1929, responsi-ble for the nation’s woes:

You brought this country to the greatest panicin human history~ . There never was such aneconomic failure in the history of mankind asyour outfit has brought upon us at this time,and it is due to this same speculation that youare defending here more than any other onething.

But these affiliates, I repeat, were the most un-scrupulous contributors, next to the debauch ofthe New York Stock Exchange, to the financialcatastrophe which visited this country and was

stance, a journalist “begged Mr. Pecora not to break somany front-page stories daily because it was physicallyimpossible to cover them all:’ See Benston (1990) for athorough, revisionist view of the hearings.

““Roosevelt (1938), pp. 11-12.““Roosevelt (1938), p. 13. His reference to “other people’s

money” was a nod to Justice Brandeis’s book of the sametitle, a reprint of his articles on the money trust that ap-peared in Harper’s Weekly in 1913-14. Those who hold thatall the great thoughts have long since been had will bepleased to learn that Kane’s (1991) reference to the “Sor-cerer’s Apprentice” segment of Walt Disney’s Fantasia asa metaphor for bank regulation was anticipated by Bran-deis. Lacking Mickey Mouse’s rendition, however, Brandeiswas forced to use the German original, Goethe’s QerZauberlehrling; see Brandeis (1933), p. vU.

‘°“Sen.Brookhart (R-IA) speaking to a New York Stock Ex-change official at a Senate committee hearing in 1932;quoted by Danielian (1933), p. 496.

mainly responsible for the depression underwhich we have been suffering since.”

In the previous year, Huey Long had announced

his intent to campaign for Roosevelt under theslogan: “Rid the country of the millionaires.u202A popular ditty mocked:

Mellon pulled the whistle,Hoover rang the bell,Wall Street gave the signal,And the country went to hell.”

In short, the bankers were vilified.

Although some felt such indiscriminate abusewas slanderous, they fought against the tide.b04One of the casualties of the anti-banker senti-ment was the bankers’ battle against deposit in-surance. Some in Congress announced that thebankers’ opinions should be openly ignored:

I believe that the myopic banker as an advisershould receive about as much consideration atthe hands of the House as a braying jackass onthe prairies of Missouri. They proved by theirinability to maintain their own business thatthey have absolutely no right to advise theHouse as to what course we should follow.”

The bankers, while they acknowledged themerit of individual aspects of the deposit insur-ance proposals, obstinately refused to coun-tenance any of the schemes as a realisticreform. Even as the legislation was signed intolaw, Francis Sisson called a crusade, rallyingABA members to fight “to the last ditch againstthe guaranty provisions” of the bill”” That thebankers’ concerns were not ignored entirelyresulted largely from the presence in govern-ment of opponents of deposit guaranties whowere more politically astute than the bankersthemselves. Sen. Glass, for example, compro-mised his principles in a bid for some controlover the legislation, explaining that it was “bet-ter to deal with the problem in a cautious and a

conservative way than to have ourselves runover in a stampede.” Roosevelt held out untilthe very end, thus forcing Congress to concedein delaying implementation of the temporaryplan until January 1934.

~ ~ ~ .n

The ramifications of deposit insurance wererecognized as far-reaching. In many ways, thecentral and most contentious battle concernedneither actuarial feasibility nor the desirabilityof protecting deposits, but the regulatory issuesof bank chartering and supervision. Because ofthe fundamental legal issues involved, it washere that the economic and political aspects ofthe debate became most fully intertwined. Thiswas a fight with the weight of a long traditionbehind it, and arguments were often self-consciously historical -

.~c7,. s.-~’~’’~ ~ 5

SuDeri•~’1Sii1fli

Bank examinations to be effective must be madeby experienced men, free from political influence.

We will never have proper banking supervi-sion, national or state, until it is taken entirelyaway from political influence.’””

Much of the blame for high rates of bankfailure throughout the l9ZOs was placed uponcompetition between state and federal authori-ties. Because banks could choose the less costlyof federal and state charters—and the associatedregulations—state and federal regulators wereforced into a “competition in laxity” if theywere to sustain the realm of their bureaucraticinfluence.”” For example, as a prelude torecommending broader powers for nationalbanks, Comptroller Pole emphasized that:

If Congress therefore would protect itself fromthe loss of its present banking instrumentality,it must make it to the advantage of capital toseek the national rather than a [state] trustcompany charter.

‘°15en.Glass, Congressional Record (1933), p. 3726. Glass isreferring to the proposed separation of investment affili-ates from Federal Reserve member banks.

“Kent (1932), p. 260.

“Kennedy (1973), p. 26.

““See, for example, Bell (1934). Sisson (1933b), p. 30,offered that the treatment of bankers as “demons of dark-ness” and as an ‘unseen mythical power for evil whichspreads its baneful influence over [human beings]” merelysatisfied an emotional need for a scapegoat.

““Sisson’s telegram is quoted in Pecora (1939), pp. 294-95.“Sen. Glass, Congressional Record (1933), p. 5862.““Andrew (1934b), p. 93.““Daiger (1933), p. 563, attributes coinage of the phrase

“competition in laxity” to Eugene Meyer in 1923 testimonyto the House Banking and Currency Committee. Thephrase attained some popularity; it was also used, for ex-ample, by Wyatt (1933), p. 186, and AwaIt (1933), p. 4.

““Rep. Dingell, Congressional Record (1933), p. 3906.

68

It is within the po\•ver of Congiess to tu,’r~theadvantage in favor of the national banks andthereby make it to the interest of all banks toopeiate under tl,e national charter”

In the eyes of opponents of deposit insurance,an especially important manifestation of thecompetition in laxity was the “promiscuousgranting of bank charters.” The immediateresult of loose chartering was a condition called“over-banking,” or

a host of weak, unreliable banks that crowdone another- out of existence by being too nu-n~erouslyorganized in places where there is nosupport for the multifarious institutions thathave been established there.”

This “indiscreet indulgence of charter appli-cants” was held responsible for the vast num-bers of bank failures throughout the previousdecade:”

There are too many banks in the United States.The areas of greatest density of banks per capi-ta coincide with the al-eas whet-c failures areproportionately highest.””

The function of a deposit guaranty under suchcircumstances would be to exacerbate theproblem by mitigating one source of publicscrutiny: inspection by depositors. Opponentsconfirmed their contention by reference to theill-fated state guaranty schemes:

In practice the guaranty of deposits plan gener-ally tended to induce an unsound expansion inthe number of banks -- - This was clearly con-nected with the indiscriminate popular confi-dence created toward the banks under theguaranty.”

It is to be feared that the adoptior~of depositguaranty laws may have somewhat retarded

the inevitably slow and unsensational process ofstrengthening the banking system by strictregulation, vigilant public opinion and strict i-c-

quirements.””

The Association of Reserve City Bankers wentfurther, predicting that managers of the insur-ance fund would be slow to close troubled insti-tutions.” In addition to regulatory competition,some saw political influence as a secondaryforce debilitating the supervisory process:

We never will have such super-vision under po-litical regulation and examination: we will neverhave arw supervision worthy of tl~ename thatdoes not have real authority and heavy respon-sibility tied to it.”

Only a few supporters of insurance addresseddirectly the plan’s implications for the regulatoryprocess, which they presented as a counter-weight to incentives for bad banking under a

guaranty. Rome Stephenson felt that the addi-tional regulatory powers in the Banking Actdifferentiated the FDIC markedly from the state

plans:

Right there is the crux of the debate: Willbanks under the federal plan be permitted theabuses which were tolerated in every one ofthe states where guaranty was tried? If so, thenfailure is inevitable, if not, success is practicallycertain.... Let me assert unequivocally that themen who drew up the federal plan profited bythe mistakes of the state guaranty failures andavoided then~ None of the state laws hadteeth in tl,em. The federal law has teeti, like aman-eating shark, and already has done somehighly effective biting.””

Carter (;lass’, x’ailing that “the Comptroller’soffice has not done its duty—its sworn duty—

“Pole (1929), p. 23.“Association of Reserve City Bankers (1933), p. 30.112H. Parker Willis, quoted in Lawrence (1930), p. 105.

“Lawrence (1930), p. 104. Lawrence took this priggish toneone step further, admonishing that “A little birth control ofbanks on the part of the states which now suffer mostfrom bank failures might have had a wholesome effect onthe rate of mortality;” ibid., p. 84.

‘‘4Westerfield (1931), p. 17; the “multiplicity of banks” wasfirst on his list of the six causes of bank failures since1920. Andrew (1934b), p. 93, concurred that “Everyoneagrees that one of the main causes of our banking troublewas too many banks.” See also Bremer (1935). AwaIt(1933), p. 4, attributes the boom in charters to “lax Statelaws” and the 1900 reduction in the minimum capitaliza-tion for national banks from $50,000 to $25,000.

““ABA (1933a), p. 42. Mississippi was held up as the excep-tion that proved the rule: “The banking authorities in Mis-sissippi had full discretion in the matter of granting newcharters and used it liberally in refusing permission

for unneeded banks or to unqualified promoters to opennew institutions;” ibid., p. 22. The result was seen to beless over-banking and fewer failures relative to Oklahomaand Nebraska.

““A Saturday Evening Post editorial of August 9, 1924, quot-ed in Association of Reserve City Bankers (1933),p. 42.

“See the quote referenced by footnote 64.““Donald Despain, quoted by Sen. Schall, Congressional

Record (1933), p. 4632.‘‘“Stephenson (1934), p. 46. In addition to authorizing the

supervisory power of the FDIC, the Banking Act of 1933:increased the punitive authority of the Federal Reserve formember banks financing securities “speculation,” prohibit-ed insider lending for member banks, authorized federalregulators to remove the officers and directors of memberbanks for illegality or unsound banking practice, and re-quired deposit-taking private banks to submit to supervi-sion by the Comptroller’s office.

and has permitted this great number of banksto engage in irregular and illicit practices,” ar-gued that mutual responsibility inherent in theinsurance plan implied mutual supervision: ifthe strong banker “knows that he has got tobear a part of the burden of my irregular bank-ing, he is going to report me to the Comptrollerof the Currency and is going to insist that hisexaminers come there and do their duty.”

The fact is, of course, that the deposit insurancescheme would not have been permitted by theconservative leaders in Congress if its organiza-tion could not have been so shaped as to furthertheir idea of a unified system of banking in thecountry under the Reserve System. On the otherhand, the more radical elements, in response topopular demand for some sort of protection forbank depositors, could not have built a nation-wide guaranty system upon any other foundationthan the Reserve organization.”

Questions about the effect of insurance on the

quality of chartering and supervision were side-shows to the main event, however. At the heartof the debate lay a decades-old controversy overthe dual banking system. Given its far-reachingnature, the proposed legislation was universallyregarded as a prime opportunity for fundamen-tal changes in banking policy.

Cotnptroller Pole had campaigned vigorouslythroughout his four-year tenure for some formof interstate branching for national banks. Hedrew a strong distinction between the small)state-chartered, rural unit bank—the “country”bank—and the large, nationally chartered insti-tution. While he pretended to maintain greatrespect for the small unit bank as the “singletype of institution which has contributed themost to - -. the foundation of our national de-velopment,” he was fighting to have them re-

placed by branch networks of national banks.’~’He justified this split sentiment by arguing that

irreversible social changes—telephone, radio,and especially the automobile—had forever obvi-ated the rural isolation that had made the unitbank competitively viable. Accompanied by along parade of statistics, he emphasized thehigh failure rate of small, state-chartered banksduring the 1920sJ” The country bank, he said,could not survive in competition with largemetropolitan institutions, which had more

professional management and were inevitablybetter diversified.

Comptroller Pole was not alone in this cru-sade. The McFadden Act had already broadenedthe branching powers of national banks; in1930, the House Banking Committee arrangednew hearings into the possibility of national orregional branch banking.”” The unsuccessfulGlass bill of 1932 included limited provisions forstatewide branching by national banks. BusinessWeek staked out the extreme position, announc-ing that “what we really need is just one big

bank with 20,000 branches.” Supporters ofbranch banking took heart in the Canadian ex-perience:

Canada has branch banking, and Canada hasnot had any bank failures during the depres-sion. Is this a matter of cause and effect?

‘It is,’ declare the advocates of branch bank-ing in the United States.””

Such highly concentrated branch networkswere offered as an alternative to deposit insur-ance as a means of geographic diffusion of loanlosses and the diversification of credit risks.”

Comptroller Pole, of course, felt branching tobe the better option:

Any attempt to main~tainthe present countrybank system by force of legislation in the na-ture of guaranty of deposits or the like, wouldbe economically unsound and would not accom-plish the purpose intended.””

Deposit guaranties had long been advocated as away of diversifying risk for the unit bank with-out a fundamental change in the ownership

“Sen. Glass, Congressional Record (1933), p. 3728.“Anderson (1933c), p. 17.“Pole (1929), p. 24.“See Pole (1930a, 1931, 1932a and 1932b), “The Need of a

New Banking Policy” (1929) and “Comptroller Pole’s Viewson Rural Unit Banking” (1930).

“4U. S. Congress, House of Representatives, Committee onBanking and Currency (1930).

“5”The Ideal Bank” (1933), p. 16.““Greer (1933a), p. 722. See also Lawrence (1930), and Rep.

Bacon, Congressional Record (1933), pp. 3949-50.

“For example, Rep. Bacon, Congressional Record (1933), p.3961, noted that “deposit guaranty is undoubtedly aguaranty of reckless banking. ... Satety for the depositorcan best be achieved by a unified branch banking sys-tem.”

““Pole (1930b), p. 5. This same sentence appears in Pole(1930a), p. 4.

structure of the banking industry.”” The vari-ous histories of Populism, “Bryanism,” the Panicof 1907 and the Pujo hearings all contained ele-ments of a deep popular mistrust of moneycenter banks. The publicity of the Pecora hear-ings in 1933 clearly did not assuage this mis-trust. It was not pure coincidence that thewestern agricultural states—the heart of theGrange and Populist movements—had been theones to enact state deposit guaranties. In thiscontext, then, it is ironic that, in 1933, federaldeposit insurance should most often have beenviewed as a lethal threat to the country bank.That it was such a threat testifies to the in-fluence and legislative skill of Carter Glass.

Sen. Glass, who had shepherded the FederalReserve Act through the House in 1913, wasprotective of his handiwork:

I took occasion to tell the Secretary of theTreasury the other day that if they pursuepresent policies much longer they will literallywreck the Federal Reserve System; thatWoodrow Wilson in history will enjoy the dis-tinction of having set up a banking system thatfought the war for us and saved the Nation inthe post-war period, and if they keep on mak-ing a doormat of it this Congress will enjoy thedistinction of having wrecked it.”

His primary concern in the banking legislationof 1933 was to buttress that system. Thus, theGlass bill required all FDIC member banks tojoin the Federal Reserve System, ostensibly togive the Fed the legal right to examine FDICmembers (the Fed was to be a prominent share-holder in the FDIC).” Because an uninsuredcountry bank facing insured competitors wasnot considered viable, and because Fed member-ship would require at least $25,000 minimumcapital, deposit insurance represented the endfor the small, state non-member banks.”Deposit insurance would force a consolidationof banking within the Federal Reserve System.

It is instructive to note that Glass had aban-doned an earlier scheme that would haveforced the same consolidation within the Fed:unification of banking in the National BankingSystem. Comptroller Pole had sought to accom-plish the same thing indirectly, by providing na-tional banks with an undeniable competitiveadvantage in the form of interstate branchingprivileges. In 1932, Glass had requested of Gov.Meyer of the Federal Reserve a constitutionalmethod of unifying banking:

Meyer: “Do you want to bring about unifiedbanking?”“Why, undoubtedly, yes.”“I shall be glad to help you.”“I think the curse of the banking busi-ness in this country is the dualsystem.”

Meyer: “Then the Board is entirely in sympa-thy with the Committee on the sub-ject.””’

The result was a legal opinion prepared by theGeneral Counsel of the Federal Reserve Boardon the constitutionality of such unification inthe absence of a constitutional amendment.””While Board Counsel confirmed that such a con-stitutional means existed, Sen. Gore introduceda constitutional amendment.”’ Constitutionalitywas crucial, because champions of the ruralunit bank were certain to raise the powerfulspecter of states’ rights in opposition:

The fight regarding the American Dual Systemof Banking is a clear-cut issue between thosewho believe in the sovereignty of our statesand home rule, and those who are in favor of a‘unification of our banking system’ into oneWashington bureau.””

Indeed, the political sensitivity of the states’rights issue was sufficient to force Sen. Glass toabandon such a direct assault on the state banksbefore it could earnestly begin.”

““White (1982, 1983, 1984) reviews the historical connections

between deposit insurance and bank chartering.“Sen. Glass, Congressional Record (1933), p. 3728~

“See the interchange between Sens. Glass and Couzens(R-Ml), Congressional Record (1933), p. 3727.

“Section 17 of the Glass bill “provides for the amount ofcapital of national banks depending upon the populationof the places where they are to be located and also pro-hibits the admission of a bank into the Federal ReserveSystem unless it possesses a paid-up unimpaired capitalsufficient to entitle it to become a national bank.” SeeGlass (1933b), p. 16, (emphasis added). The populationschedule for minimum capital was: $25,000 for areas un-

der 3000 persons; $50,000 for 3000 to 6000 persons;$100,000 for 6000 to 50;000 persons; $200,000 for areasover 50,000 persons; see Steagall (1933a), pp. 18-19.

“Quoted by Anderson (1932b), p. 678.“4The opinion was published as Wyatt (1933). The Attorney

General had felt it was not possible, and had told Glassthat; see Anderson (1932b), p. 678.

““Joint resolution S. J. Res. 18 was introduced by Sen. Gore(D-OK), Congressional Record (1933), p. 249.

““Andrew (1934b), p. 95.“See Burns (1874), pp. 11-12.

Glass:Meyer:Glass:

Arrayed against Sen. Glass in the battle forunification within the Fed was a coalition led byHenry Steagall in the House and Huey Long inthe Senate.”” Sen. Long had crippled Glass’sbanking bill in the previous Congress with aten-day filibuster; as champion of the commonman, he had objected to an envisioned concen-tration of power implicit in the bill’s branchingprovisions.”” This coalition indeed viewed de-posit insurance as a means of survival for thesmall bank:

If there is one purpose more than anotherwhich is inherent in the amendment which isnow at stake in this conference, it is the pur-pose to protect the smaller banking institutions,and to make the reopening of closed banks pos-sible as speedily and as safely as it can bedone.’~°

The final legislation was a two-stage com-promise between Sen. Glass’s push for unifica-tion and the Steagall-Long coalition’s desire topreserve the dual banking system. In the firststage, Glass agreed to support a deposit guarantyin exchange for provisions for significantly ex-panded Federal Reserve authority:

With these provisions, dependent upon them infact, the Senate bill drafters were willing to ac-cept the new Steagall bill for the insurance orguaranty of bank deposits in Federal Reservemember banks—but in member banks only.’”’

In the second stage, the dual banking support-ers obtained several concessions, most notably:

immediate insurance coverage for non-memberbanks under the temporary plan, and grand-fathering of small state banks under the new’minimum capital standards for Fed membership.Non-member banks would still have to apply forFederal Reserve membership by July 1, 1936, atthe latest. With these changes, Sen. Long sup-ported the bill, which then passed the Senatewithout objection.’”’

Prophesying the future of Federal Deposit Insur-ance is at the same time both difficult and sim-ple. It is difficult because the subject cannot betreated independently, that is, without relation tobanking structure, banking practice, political andeconomic trends and human emotions. It is easy,on the other hand, because ... any man’s guess isas good as that of another.’”’

It is obvious from an examination of therecord that the debate surrounding the adop-tion of federal deposit insurance was both wide-ranging and well informed. The banking crisisin March 1933, coming at the depths of theGreat Depression and breaking on inaugurationday, had focused attention with unique intensityon all aspects of public policy toward banks.While some contended that the urgency accom-panying the crisis injected haste into theproceedings, it also ensured that all major in-terests were roused to offer their views and ar-gue their cases.

““See Anderson (1933a), p. 17. They were loined by Sen.Vandenberg, whose temporary plan extended insurance tostate non-member banks upon certification of soundnessby the relevant state banking authority.

““There was little fondness connecting the two SouthernDemocrats. Smith and Beasley (1939), pp. 346-47, relatethat, in the heat of the banking debate and in response toa series of Long’s ad hominems, Glass unleashed a stringof invective that literally chased the Kingfish — his handsclamped over his ears — off the Senate floor. This versionof events is apocryphal, however.

~4O5~~ Vandenberg, referring to the temporary insuranceamendment, Congressional Record (1933), p. 5256. Seealso Vandenberg (1933), p. 43.

‘“‘Anderson (1933a), p. 63.‘42Rep. Luce reported that bank structure issues predominat-

ed in the conference committee reconciling the Glass andSteagall bills: “There were but two points of serious con-troversy in the discussions of the conferees — those towhich I have just referred, branch banking, the member-ship requirement together with other details of insuranceof bank deposits,” Congressional Record (1933), p. 5896.Much of the force of Glass’s requirements for Fed mem-bership was lost when deposit insurance was revampedby the Banking Act of 1935; see, for example, Woosley(1936), pp. 24-26. See also the shaded insert on the fol-

lowing page. The membership requirement was droppedentirely in 1939; see Golembe (1967), pp. 1098-1100.

Opinions varied on the significance of the consolidationof bank regulation implicit in the final act. Bankers Maga-zine editorialized that, “while this development will bringthe state banks under a considerable degree of Federalcontrol, it will not — for a time at least — result in thatunification of banking regarded by many as desirable. Thestate banks, by coming into the deposit-guaranty schemehave escaped with their lives.” “State Banks Qualifying forInsurance of Deposits” (1933), p. 490. Anderson (1933c),p. 17, warned that, “with all this variation, this glorificationof the unit bank principle, however, comes the hard factthat these institutions, for the first time in their history, willbe under one direct control whose authority is such aspractically to set aside all the principle privileges forwhich state banks have fought so long.”

‘“‘Amberg (1935), p. 49.

it has been suggested that the framers of the 1935 significantly weakened the requirementsBanking Act of 1933 failed to consider thewarnings about the potential dangers ofgovernment-sponsored deposit insurance.’~~It issignificant, then, that an examination of thehistorical record clearly shows that bill’s chiefpatrons were aware of the failure of the stateschemes, the actuarial arguments againstdeposit guaranties, and the various charteringissues involved. Moreover, they took these is-sues into account when crafting the bill. In theend, even the Association of Reserve CityBankers was able to recommend the temporaryinsurance plan:

tt appears to this Commission that if guarantyis retained after July 1, 1934 [the date for im-plementation of the permanent plani, this tern-porary plan, in sonic modified form, wouldmeet every emergency need, and eliminatemany of the dangers in the permanent plan.’~~

Under the temporary plan, coverage ceilingswere conservative, the insurance corporationwas emphatically segregated from the federaltaxpayer, chartering standards for nationalbanks were raised, and supervisory authoritywas broadly increased. These characteristicswere retained under the permanent plan of theBanking Act of 1935. As such, deposit insur-ance, as construed in the Banking Acts of 1933and 1935, succeeded in simultaneously protect-ing the small depositor and leaving the bankeranswerable to both supervisors and large depos-itors for the quality of his management.

At the same time, the deposit insurance provi-sions of the Banking Act of 1933 were used asleverage to consolidate the industry within theFederal Reserve, although the Banking Act of

for Fed membership of insured banks. Apiecemeal dismantling of other provisions of theoriginal legislation has also occurred in the in-tervening decades: coverage ceilings have risensteadily, even after accounting for inflation andbefore considering brokered deposits or too-big-to-fail policies; the full taxing authority of theU. S. ‘Freasury has, defacto, been inserted behindthe deposit insurance corporations; and deregu-lation has subjected both banks and thrifts toincreasingly harsher competition—and, in somecases, relaxed regulatory scrutiny—withoutsimultaneously making bankers responsible todepositors for the riskiness of bank assets.’4°Itis perhaps with this more recent negation of in-dividual elements of a complex and interdepen-dent package of bank reforms that we shouldseek the proximate cause of our recent depositinsurance troubles, rather than with policyflaws in the Banking Act of 1933 itself.

This list of references contains several sources that are rele-vant to the debate, but which are not cited directly in the text.These additional references are included to provide others in-terested in the topic with a more comprehensive listing of theprimary source materials.

“A Good Start,” Bus/ness Week (March 22, 1933), p. 32.Amberg, Harold V. “The Future of Deposit Insurance,” As-

sociation of Reserve City Bankers: Proceedings, Twenty-fourth Annual Convention (1935), pp. 49-61.

American Bankers Association (ABA). “The Guaranty ofBank Deposits,” (Economic Policy Commission: AmericanBankers Association, New York, 1933a).

________ “Forum Discussion—Uniform Banking Law—Guar-antee of Deposits,” Commercial and Financ/a/ Chronicle(American Bankers Convention Supplement, September 23,1933b), pp. 58-59.

““Kaufman, for example, claims that the opinions of Emer-son (1934)— and, by association, those of the bankingcommunity as a whole — regarding flaws in the actuarialbasis for the plan were unheeded at the time.

In particular, Kaufman (1990) states, pp. 1-2: “Some ofthe problems are new, however many have been aroundfor many years and were even clearly foreseen at the timethey were forming or, worse yet, even earlier. at the timetheir underlying causes were put in place in the form oflegislation or regulation. This is the case with the extantstructure of federal deposit insurance. Among those fore-casting the problems that this innovation would come tocause was Guy Emerson, a long-time economist for theBankers Trust Company (New York). His warnings are evi-dentin his article “Guaranty of Deposits Under the Bank-ing Act of 1933” published in the February 1934 QuarterlyJournal of Economics and reprinted in this volume. Muchof this book is necessitated because policy makers did notlisten to Emerson and others more than half a centuryago.” Related remarks appear on pp. xi-xii of the prefaceto the same volume.

‘“tmAssociation of Reserve City Bankers (1933), p. 7. Theywere, however, at pains not to appear eager in theirpraise: “What we are recommending, therefore, is co-operation in an emergency measure of fhe sort that hasbeen deemed necessary in a/most all branches of our eco-nomic life, but we are not, directly or indirectly, endorsingthe principle of deposit guaranty” ibid., p. 7. (emphasis inthe original). The permanent plan was never operational;it was in fact ultimately superseded by a modified form ofthe temporary plan.

‘“6The technical legal question of the de jure liability of theUnited States government for deposit insurance is surpris-ingly complex, and the answer is not entirely clear. As apractical matter, however, the question is neither complexnor unclear. See FDIC (1990). pp. 4438-39.

74

“Report of Resolutions Committee—Insurance ofDeposits Declared Unsound,” Commercial and FinancialChronicle (American Bankers Convention Supplement, Sep-tember 23, 1933c), p. 59.

American Savings, Building and Loan Institute. Guarantee ofBank Deposits and Building and Loan (American Savings,Building and Loan Institute, Chicago, 1933).

Anderson, George E. “The Glass Bill is a Medley,” Amer/canBankers Association Journal (February 1932a), pp. 498,532-35.

“Washington Looks at the State Banks,” AmericanBankers Associat/on Journal (May 1932b), pp. 677-78, 718,

_______- “Bank Law Making,” American Bankers Associa-tion Journal (May 1933a), pp. 17, 63.

________ “The Price of Deposit Insurance,” AmericanBankers Association Journal (October 1933b), pp.17-19, 51.

“Washington Epic: II. Prospectus—National Finan-cial Control,” American Bankers Association Journal(November 1933c), pp. 16-17, 48.

“Deposit Insurance, First Phase,” AmericanBankers Assoc/ation Journal (January 1934a), pp. 20-21.

______ “Bank Owners,” Banking (November 1934b),pp. 11-12.

Andrew, L. A. “Reconstruction: Individual Initiative,” Amen-can Bankers Association Journal (January 1934a), pp. 15-16, 53, 69.

______ “The Future of the Unit Bank,” Proceedings of theForty-fourth Annual Convention of the Missouri Bankers As-sociation (1934b), pp. 91-101.

“Are State Banks to be Suppressed?,” Bankers Magazine(November 1929), pp. 663-64.

Association of Reserve City Bankers, Commission on Bank-ing Law and Practice. “The Guaranty of Bank Deposits[Bulletin No. 3, (Chicago, November 1933).

Await, F G. Annual Report of the Comptroller ot the Cur-rency, 1932 (U. S. Government Printing Office, Washington,D.C., 1933).

“Bank BilL” Business Week (June 10, 1933), p. 8.

“Bank Reform,” Business Week (January 4, 1933), pp. 3-4.“Banking Issues in the Campaign,” Amer/can Bankers As-

sociation Journal (August 1932), pp. 22, 65.‘Banking Reform,” Bus/ness Week (March 8, 1933), p. 32.“The Banks Reopen,” Business Week (March 22, 1933),

pp. 3-4.Beebe, M. Plin. “A National View of State Banks:’ American

Bankers Assoc/ation Journal (October 1931), pp. 217-18, 287.Bell, Elliott V. “The Bankers Sign a Truce,” Current History

(December 1934), pp. 257-63.“Who Shall Rule the Money Market?,” Current

History (July 1935), pp. 353-59.Bennett, Frank F, Jr. “A Word to National Banks:’ Ameri-

can Bankers Association Journal (October 1931), pp. 232-33, 272.

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