Economics and The Public Welfare

Chapter 32

Late 1930—Hitler Gains; Bank of United States Crashes

The second half of 1930 saw the shadows deepening. Interest rates continued to decline under the influence of Federal Reserve policy. The open market commercial paper rate dropped to 3% in the third quarter, and below 3% in the fourth quarter. The rate on bankers’ acceptances went under 2% in the third quarter and declined further at the year end, while the New York Federal Reserve Bank discount rate dropped to 2% as the year end came. But the cheap money magic was over. Declining interest rates were a feeble candle in the midst of growing gloom.

Quality of Credit Questioned—Foreign Bonds and Mortgages. The real forces which governed business and markets were of a different character. Exports and imports were declining. The curve of industrial production moved steadily downward. The level of commodity prices moved rapidly downward. Questions were being raised regarding the quality of credit, and particularly, regarding foreign bonds and real estate mortgage bonds. Real estate values were being questioned, and the market for second mortgages and third mortgages (documents which multiply in a real estate boom) became demoralized in the extreme.

Hitler Danger Recognized. The foreign bond picture, badly shaken by the Smoot-Hawley Tariff Bill, was further shaken by the German election held Sunday, September 14, 1930. Down to this time Hitler’s name had not been well known in the United States and, where it had been known, it had been looked upon as merely a bad joke. There had been a good deal more apprehension in Germany itself than elsewhere. But even in Germany, the disposition had been generally to look upon him as a troublesome irritant rather than a serious danger.

In this election, however, he showed real strength. In the campaign which preceded the election, there was a real scare in Germany. Hitler made a strong appeal to many discontented elements, including young men of good family who had been kept out of the civil service by the dominant Social Democratic Party, and who had no opportunities for military careers because the Germany Army was held down to 100,000 by the Treaty of Versailles. He appealed to the growing body of unemployed in Germany, and he appealed to national sentiment as a whole in his denunciation of Reparations and in his denunciation of the Young Plan of 1929, which revised the Dawes Plan and under which a new German International Bond issue had just been floated. In the election, he showed real strength. He gained 107 seats in the new Reichstag as compared with 12 seats held in the previous Reichstag. In the total popular vote, there were 35,000,000 ballots cast, of which 8,572,016 were for the Social Democrats; 6,401,210 were for the Hitlerites (the National Socialists, or Nazis, as they were beginning to be called); 4,587,708 were for the Communists; and the rest were distributed among the Catholic Centrists and other older parties. Hitler’s party thus stood second in size among the parties, no one of which had a majority. That he got so few votes brought relief to German opinion, but that he got so many created grave concern in the financial world outside of Germany. There were definitely bad reactions both in stocks and in bonds as a result of this election.

Bank of United States. By the year end, markets were dominated by an acute domestic development. The Standard Statistics Average of 420 stocks, which had stood at a little over 70 in the first quarter of 1924, rising to 225 at the peak of 1929 (monthly figures), had dropped to 150 at the low of 1929, and in the first half of 1930 had risen again to 170. The reaction in May and June was sharp and brought the level back to around 150 again. August and September showed a measure of resistance. By the end of the third quarter a drastic decline was again under way, helped very definitely by the Hitler election, but speeded up and intensified by the trouble with the Bank of United States, which occasioned grave concern during the last quarter of 1930.

The Bank of United States was a bank which ought never to have existed, and which certainly ought never to have had the name which it had. One leading banker of New York went personally to Albany to protest against the giving of such a name to that bank or to any other bank, and was told that there was a political debt to pay. In the period 1924 to 1929, with excess reserves and rapid bank expansion, it was easy for plungers and speculators to grow rapidly. There was a heavy discount on sound banking, and a high premium on reckless plunging. One watched it with apprehension, afraid not merely that bankers would lose their judgment but also that in many cases moral standards would crack.

We must pay high tribute to the banking profession of the United States with respect to this latter point. In very few cases did moral standards crack. In many cases judgment went bad, and in more cases traditional practices, sound and tested, proved bad practices in such an abnormal money market. But the great majority of American bankers kept their integrity and tried to adhere to established and approved banking practices. But it was an era in which the bold speculator and promoter could gain ground rapidly at the expense of the conservative banker, and it was a period in which departures from convention and approved banking practices would seem to be brilliant strokes of genius—while the new era lasted.

The Bank of United States grew very rapidly down to 1929. The name itself meant, as it was designed to mean, to many of the ignorant people of Europe, that this was the national bank, the state bank, the official bank of the United States. Deposits came to it from a great many of those people and from a great many of the ignorant and the poor on the East Side of New York. And a great deal of business was brought to it, too, by men engaging in speculative activities who could get the desired kind of accommodation from this bank which the other banks of New York would not give. Loans against mortgages were generally looked at askance by great New York banks. The first principle of commercial banking is to know “the difference between a bill of exchange and a mortgage.” Second mortgages and third mortgages were notoriously improper documents in a bank’s portfolio or as collateral to its loans. But the Bank of United States went in heavily for these. It had an affiliate also—the Bankus Corporation. This was engaged in many yet more questionable transactions, including manipulation of the stock of the Bank and loans against the stock of the Bank. In addition to the utterly unsound banking practices, there were definitely criminal acts for which the head of the bank subsequently went to prison—not unaccompanied.

When the first mortgages grew shaky, when second and third mortgages had no market, and when the bank’s stock was crashing, the Bank of United States and its affiliate, the Bankus Corporation, were in grave peril. Depositors grew very uneasy and they made heavy withdrawals of funds.

Unsuccessful Efforts to Save It. The great New York Clearing House banks, the Federal Reserve Bank, and the State Superintendent of Banking, Joseph A. Broderick (who had no part in giving the name to the Bank and whose job was primarily salvage), made strenuous efforts to save the situation. The great Clearing House banks were prepared, in the interest of the good name of banking in New York, to stand part of the losses. On Monday, November 24, 1930, it was announced that there would be a merger of the Bank of United States with The Manufacturers Trust Company, The Public National Bank and Trust Company, and The Interstate Trust Company, with J. Herbert Case, Federal Reserve Agent and Chairman of the Board of Directors of the Federal Reserve Bank of New York, as head of the merger.

This looked like an admirable solution of the problem. The financial community breathed a great sigh of relief when it appeared that J. Herbert Case thought that this situation could be solved in this way. It appeared that the aggregate capital funds of all these banks would suffice to absorb the losses and still leave a strong institution. But the agreement was a contingent agreement, and the other banks were to have time to look with great care at the assets of the Bank of United States. As they looked at these assets, the merger clearly became impossible. The officials of the other banks and J. Herbert Case could not assume the responsibility for such a mess. The problem remained. The Clearing House worked hard upon it.

A conference, lasting beyond midnight, of leading New York bankers sat with Mr. Broderick, State Superintendent of Banks, on the night of December 10 and the early morning of December 11. A plan was worked out by which a wholly new management, under the presidency of the head of one of the small but sound banks of the city, was to take over the Bank of United States with the guaranty of the great Clearing House banks against loss. But as this able young president and his associates, accustomed to clean, sound banking, looked at the assets of the Bank of United States, looked at the second and third mortgages, looked at the tangled and involved transactions they would have to deal with, they declined. They did not know how to do that kind of banking. No other New York bank knew how to do that kind of banking. On Thursday morning, December 11, 1930, the Bank of United States was closed.

To ease the shock and to relieve the plight of the depositors of the bank, the other banks of the city agreed to make loans against deposit accounts in the Bank of United States up to 50% of their face value.

With the announcement of the closing of the Bank of United States, the stock market plunged still lower. Money remained extraordinarily cheap in this stock market crisis. Call loan renewal dates ranged from 2% to 2.3% between December 13 and December 27. But cheap money could not help the stock market in a situation like this. It reached a wide-open selling climax on Wednesday, December 17. Then, as is usual after a selling climax, it rallied, and the rally carried over through the early months of 1931.