Between the Civil War and the Great Depression, the United States had a famously crisis-prone banking system. Even then, banks were regulated: most banking was carried out by “national banks” that were regulated by the federal government and subject to rules involving reserves and capital, of the kind described below. However, there was no system of guarantees for depositors. As a result, bank runs were common, and banking crises, also known at the time as panics, were fairly frequent.

Table 17-1 shows the dates of these nationwide banking crises and the number of banks that failed in each episode. Notice that the table is divided into two parts. The first part is devoted to the “national banking era,” which preceded the 1913 creation of the Federal Reserve—which was supposed to put an end to such crises. It failed. The second part of the table is devoted to the epic waves of bank failures that took place in the early 1930s.

The events that sparked each of these panics differed. In the nineteenth century, there was a boom-and-bust cycle in railroad construction somewhat similar to the boom-and-bust cycle in office building construction during the 1980s. Like modern real estate companies, nineteenth-century railroad companies relied heavily on borrowed funds to finance their investment projects. And railroads, like office buildings, took a long time to build. This meant that there were repeated episodes of overbuilding: competing railroads would invest in expansion, only to find that collectively they had laid more track than the demand for rail transport warranted. When the overbuilding became apparent, business failures, debt defaults, and an overall banking crisis followed. The Panic of 1873 began when Jay Cooke and Co., a financial firm with a large stake in the railroad business, failed. The Panic of 1893 began with the failure of the overextended Philadelphia and Reading Railroad.

As we’ll see later in this chapter, the major financial panics of the nineteenth and early twentieth centuries were followed by severe economic downturns. However, the banking crises of the early 1930s made previous crises seem minor by comparison. In four successive waves of bank runs from 1930 to 1932, about 40% of the banks in America failed. In the end, Franklin Delano Roosevelt declared a temporary closure of all banks—the so-called “bank holiday”—to put an end to the vicious circle. Meanwhile, the economy plunged, with real GDP shrinking by a third and a sharp fall in prices as well.

There is still considerable controversy about the banking crisis of the early 1930s. In part, this controversy is about cause and effect: did the banking crisis cause the wider economic crisis, or vice versa? (No doubt causation ran in both directions, but the magnitude of these effects remains disputed.) There is also controversy about the extent to which the banking crisis could have been avoided. Milton Friedman and Anna Schwartz, in their famous study A Monetary History of the United States, argued that the Federal Reserve could and should have prevented the banking crisis—and that if it had, the Great Depression itself could also have been prevented. However, this view has been disputed by other economists.

In the United States, the experience of the 1930s led to banking reforms that prevented a replay for more than 70 years. Outside the United States, however, there were a number of major banking crises.