Systematic problems in the banking system usually lead to large-scale economic crises. At the onset of America’s Great Depression between 1929 and 1933, 11,000 banks—almost half of all U.S. banks—failed. The ripple effects were grim. Many people lost their life savings; they also had to curtail their spending, which meant that many businesses lost their customers and thus revenue. Many businesses were unable to get loans or daily working capital. Thus, bank failures were followed by a rash of small business failures. It took many years before the American banking system, and the American economy, recovered.

In their seminal work, A Monetary History of the United States, 1867–1960, Milton Friedman and Anna Schwartz argued that the Great Depression was brought about, in part, because the Federal Reserve—the U.S. central bank that is charged with overseeing the general health of the banking industry—failed in its job to prevent widespread bank failures.7 (See Chapter 13 for further discussion of the Great Depression and Chapter 15 for more on the Federal Reserve.) Economist Ben Bernanke later showed that one of the reasons why bank failures were so crucial in the onset of the Great Depression was because banks provide loans to a particular class of borrowers and lenders.8 According to Bernanke:

As the real costs of intermediation increased, some borrowers (especially households, farmers, and small firms) found credit to be expensive and difficult to obtain. The effects of this credit squeeze…helped convert the severe but not unprecedented downturn of 1929–30 into a protracted depression.

By the way, if you recognize Bernanke’s name, it is with good reason: He was chairman of the Federal Reserve between 2006 and 2014 when he had to face the worst intermediation crisis since the Great Depression.