U.S. Banking Crashes, Three Episodes

In Economy on March 3, 2010 at 3:00 AM

Compared here and revisited are three banking-centered recessions dominating the unpopular imagination from 1900 onward: namely, the Great Depression period, the Savings & Loan Crisis period and the Subprime Recession period. In looking back, contrasted are usual traditional monetary measures one encounters in Mankiw (2003), e.g., the money multiplier, monetary base, reserves-to-deposits ratio, etc., with aim to assess and draw distinctions between the three larger bank failure periods in modern American recall and imagination.

In confronting United States of Amnesia syndrome, considered upfront ought be the most recent crisis having technically ended in the 2009 third quarter — GDP posted a positive result then, after 4 consecutive quarters in terra negativa. This most recent Subprime Recession began in the mortgage backed securitization arena, where people bundled and morphed poorly underwritten mortgages, low-grade student loans and more into bonds that payed off to a stream of investors only if the housing markets nationally continued to remain uncorrelated in time, as one narrative goes.

In spectacular fashion, American International Group (AIG) managed to insure far too many of such bonds, premised on this faulty assumption, only to fail and be bailed out directly alongside its clients/counterparties indirectly.

Other people have tried to place the burden of blame on The Community Reinvestment Act, or C.R.A. legislation. Whatever the case, Fannie Mae and Freddie Mac, the secondary mortgage market underwriters who aided in fueling the boom in real estate lending, apparently have not yet been significantly reformed, and are becoming riskier by the day — watch The Center for Responsive Law’s forum hosted in January.

For some, Nomi Prins, finance writer/author and retired Goldman Sachs Managing Director, provides more interesting entries and interviews on this chapter in Wall Street history. For others, Washington’s official Financial Crisis Inquiry Commission is reporting a broader introspection, as led by inspector Phil Angelides. On a side note of interest, there is a rumor that Oliver Stone is taking to the pen to conjer up Wall Street II, the movie, in a reprise sequel.

As for analysis, here are some figures possibly of worthwhile interest. As one can see, Figure 1 charts currency-to-deposits over particular date ranges. As is typical with this sort of analysis, I align the different time periods around peaks of production as outlined in the official NBER Business Cycle Dating Committee Memo. Corresponding table — U.S. Banking Crashes, Three Episodes — provides additional detail on quantity levels and dates for the variables plotted.

Figure 1 represents a proxy for classic bank runs on deposits. Northern Rock, one may recall, in England back in September 2007 suffered this ancient, regrettable affair early in the crisis having passed. As one would expect, the Great Depression data confirms such an interpretation here, rising by a factor 1.25 increase in intensity measured from August 1929 up to 2 years out. Economics reminds us that the current U.S recession has benefitted firmly from Federal Deposit Insurance Corporation (FDIC) insurance on deposits, as noted in the figures; therefore, the 0.77 reading holds true to interpretation.

Figure 2 readies a second interpretation notably of interest, this time from the perspective of the bank, measuring it’s willingness or unwillingness to lend money out to potential borrowers. The idea: If a dollar is not lent then it is held in reserve at the bank. Certainly, banks have generally been unwilling to lend, as the data displays. For instance, Table 2 evidences a 17.78-fold increase in the reserves-to-deposits ratio during the Subprime Recession; really an unbelievable number when compared to the other very severe banking crises.

Final graphics in Figures 3, 4 and 5 grant a key glimpse at what the central bank has been confronting from a monetary lever standpoint. The multiplier, that is, the speed at which monetary base (currency + reserves, as exogeneously controlled by the Federal Reserve) translates to end money supply, has “gone off a cliff” over the period of analysis relative to peer comparisons. One can see here clearly just how much the Federal Reserve has moved to leverage its efforts to reverse/diminish the fallout to the real economy as threatened by the residential real estate boom and bust.

In the larger scheme of things, the central bank may control monetary base — and indeed monetary base did increase over the 1930s Depression date range — but it can, always and everywhere, only propagate its monetary transmission as smoothly as the marginal propensity of lenders will allow. Provenly, FDIC insurance picks up the other end of the equation effectively as a key stabilizer.

* N. Gregory Mankiw, Macroeconomics, Worth Publishers 7th ed. (2003): 547-556.

  1. Very interesting analysis!

    You may want to consider adding “Public Debts as the Root Causes of Unustainable Economies” to your thinking. See http://bit.ly/9NBZsv

    Also, a “banking crisis” is not nearly as devastating as an “economic crisis”. But let’s face it: the domination of the real industry by the financial one is ultimately the goal of the global financial elite.

    CrisisMaven’s Blog is a great resource, too.

    With best wishes,
    Organiser, Forum for Stable Currencies

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