Economics and The Public Welfare

Chapter 36

The Year 1932

Slaughter in Security Prices, September, 1931-July, 1932, The period from September, 1931 to midsummer, 1932 was one of deep gloom. Securities of all kinds tumbled. The stock market moved down drastically. Standard & Poor’s common stocks index (1935-1939 = 100), which had stood at the average price of 103.7 for the month of July, 1931, dropped to 61 as the average for December, and to 35.9 as the average for June, 1932. On monthly averages there were no rallies in this long decline, which was the greatest in percentage for the whole period of decline following September of 1929. February of 1932 shows a rally inside the month. Thus, the New York Times average of 50 stocks, 25 rails, and 25 industrials rallied from 65.62 on February 10 to 80.56 on February 19 of 1932, but then started again on an almost uninterrupted decline to a low of 33.98 in July of 1932—a break of over 58% in five months.

Even more startling was the break in the price of bonds in the winter of 1931-1932. Even United States Government bonds yielded moderately. Moody’s corporate “Aaa” bonds moved downward sharply, the declining prices being reflected in a rise in yield from 4.40% in August, 1931, to 5.32% in December, 1931. The slaughter in less highly rated bonds was appalling. Moody’s corporate “Baa” bonds, which had a yield of 7.47% in August of 1931, were yielding 10.42% in December, and by May of 1932 this yield had risen to 11.63%. Fear ran over the market regarding all bonds not absolutely secure. There were bonds in the “Baa” list, undoubtedly good by credit standards, “money good,” which were selling in the low 60’s and in the 50’s. The average yield for railroad bonds, which had been 6.01% in August, 1931, had risen to 9.30% by May of 1932.

Drop in Production. Industrial production dropped with startling rapidity, the Federal Reserve Index (1923-1925 = 100) dropping from 80 in the late summer of 1931 to below 60 in the summer of 1932. In late July, 1932, the tide began to turn, and the autumn of 1932 showed a decided rally with respect to all these matters.

Good Record of Strict Brokers’ Loans. The strict brokers’ loans made a magnificent performance. The total of brokers’ loans in New York had stood at $8,500,000,000 at the peak of 1929, and were paid down to something like $300,000,000 by midsummer of 1932. I think it is correct to say that there were almost no losses on strict brokers’ loans, i.e., those made in the regular way against diversified, readily marketable collateral and with regular margins. These loans, scrutinized every day, with margin calls whenever margin deficiencies appeared, with strict scrutiny of collateral as substitutions of collateral were made, and with great care that diversification be at all times adequate, made an extraordinarily fine record.

Severe Losses on Other Security Loans. But the banks had losses in loans to brokers made to the brokers in their capacity of customers of the bank, and the banks had heavy losses on security loans to other customers. This was particularly true of loans made against large blocks of one type of security, and was particularly true of loans made by one bank against the stock of another bank. Losses were frequently severe in cases where officers of interior banks, holding stocks of their own banks for which the market was narrow, had negotiated loans against these stocks with their city correspondents.

And on Real Estate Loans. Very heavy losses came in connection with real estate mortgage loans. The major banks in New York City held comparatively few of these. The one New York City bank which had gone in most heavily for this kind of paper, the Bank of United States, had, as we have seen, blown up at the end of 1930. But in the country districts and in the smaller cities there had been altogether too many mortgage loans made by banks, and in one great city, Detroit, the pressure was very heavy, due in part to this cause. The ultimate salvage on this kind of loan proved better than anticipated, but for banks under pressure to get cash to meet depositors’ withdrawals in 1932 and early 1933, such paper had very limited availability.

There had been an immense issue of real estate mortgage bonds, and real estate mortgages, and a great excess of new building. With the decline of earnings in city real estate, and the break in real estate prices, the foundation of these mortgages was undermined, while, with the virtual collapse of agricultural prices, farm mortgages presented a sorry picture.

The Tragedy of Agriculture—Industrial Unbalance. Basic, of course, in the agricultural situation was the collapse of the export markets, due first to our high tariffs; second, to the immense volume of foreign indebtedness, including the intergovernmental debts; and third, to the rapidly growing trade restrictions, including tariffs, quotas, foreign exchange controls, and other devices which the debtor countries of Europe, normally our customers for agricultural goods, were rapidly erecting.

Agricultural commodity prices, which had stood well above 100 in 1927-1929, dropped to 50 by February of 1932, and went as low as 47 by the rummer of 1932. The general level of commodity prices had a much less extreme swing. Averaging around 97 in 1927 to 1929, it had dropped to 68 by early 1932, and to a low of 64 in the summer of 1932. Farm commodity prices had been better than the average of commodity prices in the years 1927, 1928, and 1929, but dropped far below the average in 1931 and 1932. While the heavy volume of foreign loans was being made in the 1920’s, farm prices were being maintained and our farm exports went to Europe in good volume. With the cessation of those foreign loans, our tariffs got in their strangling effect, and with the raising of the tariff in 1930, farm prices almost immediately dropped below the general average of prices, and sank to unprecedented depths. With the immense decline in agricultural prices, the domestic market for manufactured goods was badly weakened, and unemployment grew rapidly in the cities because the farmers could not buy the products of the city workers. We had grave industrial unbalance.

The Glass-Steagall Act. In the first two months of 1932 there were further withdrawals of gold by foreign countries, and our gold monetary stock declined by $106,500,000. Our banks were under increasing pressure.

A remedy was found in the Glass-Steagall Bill, introduced on February 11, 1932, rapidly put through the Congress, and signed by the President on February 27. This Act authorized the substitution of Government securities for commercial paper as collateral for Federal Reserve notes for a period of one year. This was contrary to the original theory of the Federal Reserve Act. It was an emergency measure somewhat analogous to the “Suspension of Peel’s Act” employed by the Bank of England, with the sanction of the government, in great crises in Great Britain after 1844. It would have been wholly unnecessary if Federal Reserve policy in the preceding period had been sound policy. As an emergency measure, however, it was itself sound.

When word reached New York that Senator Glass was willing to have this done and would sponsor it, the effect was very great. Senator Glass had immense prestige in the financial community. It was recognized that he had been opposed to the follies in the preceding period. It was recognized that he would not sanction anything which he did not believe to be sound. The fact that he did sanction this measure meant to the broker and banker in Wall Street that the extreme pressure could be removed. The Dow-Jones average of industrial stocks rose 14 points from a close of 71.80 on February 10, when Senator Glass’s position was announced, to a close of 85.82 on February 13.

The Reconstruction Finance Corporation. We have already referred to two other relief measures which came in the critical winter of 1931-1932. The first was the National Credit Corporation organized by the banks at the request of President Hoover, whereby $500,000,000 was made available for the relief of banks which had good paper, but paper ineligible for rediscount at the Federal Reserve banks. When this corporation was organized the President promised that he would ask the Congress as soon as it assembled to create a Government corporation to take over the rescue work. The National Credit Corporation was an interim organization. President Hoover made good his promise, and the Congress acquiesced.

The Reconstruction Finance Corporation was created by Act of Congress signed by the President on January 22, 1932. It was provided by the Congress with capital of $500,000,000 and empowered to issue its debentures to the amount of $1,500,000,000. With the Reconstruction Finance Corporation we had put ourselves in position to give banks with assets which were good but slow, opportunity to mobilize their slow assets to meet quick liabilities. With the Glass-Steagall Act we had put it into the power of the Federal Reserve banks to buy Government securities so as to relieve money market pressure.

We knew that it was in the power of the foreigners to make further heavy gold withdrawals, but we had put ourselves in a position to stand these heavy gold withdrawals and still maintain a comfortable domestic money market.

The Federal Reserve banks immediately began a programme of Government bond buying.

The Second Foreign Run on Our Gold Met without Shock. The second great foreign run on our gold came in the spring of 1932. Our gold monetary stock dropped over $450,000,000 between the end of March, 1932, and June, 1932. We met this withdrawal without any shock at all. One of the fears which had made the gloom in the winter of 1931-1932 was the fear of further foreign withdrawals of gold, with the resultant further acute tightening of our money markets. But we met this second foreign withdrawal with a steady decline in our interest rates. The renewal rate on call money at the Stock Exchange held around 2 1/2% as the gold was going out. The Federal Reserve rediscount rate in New York, holding at 3% while the run was on, dropped to 2 1/2% when it was over. Open market commercial paper, standing at 3 3/4% at the beginning of 1932, had dropped to 3% by the middle of the summer. The rate for customers’ loans in the great city banks declined moderately even while the run was on.

The Glass-Steagall Bill, permitting Federal Reserve banks to resume their purchases of Government securities, stopped the contraction. Member bank reserves rose again from $1,878,000,000 on February 24, 1932 to $2,192,000,000 by May 18, 1932. Money market pressure was decisively relieved.

Quality of Credit vs. Money Market Ease. But quantity of money and credit are less important than quality of money and credit. There remained deep wounds, and the curve for the stock market, after a short-lived rally on Senator Glass’s endorsement of the Glass-Steagall Bill, moved down decisively in the greatest percentage break of the whole decline, that from February, 1932, to July of 1932, and to levels that were appallingly low. The curve for industrial production, moreover, continued to move down with scarcely an upward ripple into decisively lower territory in the summer of 1932.

Runs on Banks—Chicago. Weaknesses in the structure of individual banks, or supposed weaknesses, continued to create runs on banks. Grave fears and disorders arose in connection with the Chicago banking situation in particular. Money in circulation which had stood at the end of August, 1931, at $4,765,000,000, rose to $5,193,000,000 by the end of May, 1932, and jumped further in the single month of June to $5,408,000,000, representing primarily money hoarded by people afraid of banks. Unemployment grew to unprecedented levels. It was a gloomy and distressing period.