America’s Money Machine

MEANTIME, along with the relaxation of banking discipline permitted by reserve requirements, an extraordinary change had been going on in the direction in which credit was flowing. We have already noted the vast increase in security speculation. Some further details are in order.

Between June 30, 1921, and June 30, 1929, total loans and investments of member banks increased from $24,121 million to $35,711 million. At the same time, ordinary commercial loans, which traditionally should form the major portion of the assets of deposit banks, fell from one-half to one-third the total. It is a remarkable fact that these loans were actually less in the boom year of 1929 than in the depression year of 1921 in spite of a rise of nearly 80 per cent in industrial production. These loans stood at $12,844 million on June 30, 1921, and at $12,804 million on June 30, 1929.

During these eight years, the more speculative and less liquid loans on securities and urban real estate together rose nearly $8 billion, representing almost three-fourths of the total increase in loans and investments during the period. Diversion of credit into these markets had the two-fold consequence of financing a prolonged and colossal speculation and of loading the banks with the kinds of assets which are particularly difficult to liquidate under conditions of declining prices. From 1922 to 1929, the ratio of loans on securities to total loans and investments of reporting member banks advanced from 25 per cent to somewhat more than 43 per cent; while from 1924 to 1929, the prices of industrial common stocks more than tripled, as we have noted above. On September 30, 1929, New York banks and trust companies alone had over $7 billion loaned to New York Stock Exchange brokers to finance security speculation.

In addition to the bank credit that flowed into the security markets through stock collateral loans, vast amounts of bank credit were used indirectly, through the investment banking system, in the flotation of new issues. During the five years ending 1924, the average annual volume of new capital issues, exclusive of refunding issues and United States government issues, was $4,280 million. During the next five years the average annual volume mounted to $7,730 million and in 1929 over $10 billion of new capital was subscribed. The total amount of new money made available to corporations, states and municipal bodies, and to foreign governments and corporations, either by way of shares or loans, was in excess of $38 billion in these five years. All these loans and security flotations were sustained and assisted by the use of bank credit.

Not only did the commercial banks assist the process of security speculation by financing the investment banker and the pseudo-investor, but they purchased large blocks of bonds outright. The prospects of high yields and large profits from the turnover of investments filled the portfolios of banks with many high coupon bonds of foreign governments and corporations and with second, third and fourth grade bonds of American companies and municipalities. Between 1921 and 1929, member banks’ holdings of securities, aside from United States government securities, increased from $3,507 million to $5,921 million. The result was to convert many a bank from the status of a commercial credit institution to that of an investment company. The unsoundness of this process became apparent later when banks had to liquidate these holdings on a falling market. It was a policy of borrowing at short term (using deposits which are payable on demand) and lending at long term (for bond holdings, despite the fact that they are marketable, are loans at long term) which the banks would never have tolerated on the part of their commercial customers.

A second outlet during the nineteen twenties for the excessive credit created by the banking system was in financing urban real estate. We have already commented upon the Florida land boom. This was not an isolated phenomenon. During the decade 1920-1930, the movement to the cities had accelerated: the population of the sixty-three metropolitan zones (cities of 100,000 or more, plus adjacent counties) rose from 46,491,000 to 59,118,000, or from 44 per cent of total population to 48 per cent. Seventy-four per cent of the increase in total population during the decade occurred in the metropolitan areas.

A building boom had followed, with the Federal Reserve Board index of building contracts awarded, 1923–1925 taken as 100, rising from 63 in 1920 to 122 in 1925, and 135 in 1928. A characteristic of this activity was that it was concentrated largely in skyscraper offices and expensive apartment house developments, whose notes were more readily marketable, rather than in the modest single family accommodations. The result was that when the era had passed the slums still existed, like rats’ nests around the whitened skeletons of downtown mastodons.

The part played by the Federal Reserve System in this unbalanced real estate activity may be noted. Until 1927, national banks were limited in their real estate loans to amounts no greater than 25 per cent of their paid-in capital and unimpaired surplus or one-third of their time deposits; nor could they make loans on improved real estate for more than one year. In 1927, in response to demand for liberalization of these requirements, the MacFadden Act was passed permitting the making of real estate loans to 25 per cent of paid-in capital and unimpaired surplus or one-half of time deposits. In addition, banks could now extend loans to a maximum of five years.

Thus, so effective had been the smiting of the rock that by 1929 the United States was overwhelmed by a flood of credit. It had covered the land. It was pouring into every nook and cranny of the national economy. Flimsy structures of business—the speculative and trading element—it carried away on the crest of the wave, while those of a more substantial and conservative sort it either submerged or destroyed by undermining their foundations.