Development of US Banking Lesson 2.3 Banking in the 20 th Century

Lesson Objectives  Explain why Congress established the Federal Reserve System.  Identify challenges that the banking system of the United States faced in the 20 th century.

I. A TRUE NATIONAL BANKING SYSTEM  Prior to 1913, America transitions into industrial powerhouse.  Massive Industrialization caused high demand for money and credit.  With banks tied closely together, sudden economic downturns caused chain reactions.  A few banks stressed the entire system because lack of reserve liquidity.

A. Federal Reserve Act of 1913  Founded based on a recommendation of a special bipartisan group (formed by Congress).  Established adaptability and flexibility in banking system.  Board of directors controlled district reserve from which member banks could borrow to meet demands.

Federal Reserve  Handled government’s central banking function.  Conducted bank examinations.  Decided whether or not banks could borrow money.  Monitored and protected entire banking system.  Has changed since 1913, both in structure and operation.  Today, it plays a key role in the economy.

B. Banks in Crisis Great Depression (1929 – 1939)  Worst and longest economic crisis in western nations.  October 1929, stock market crashed causing a near-collapse in the US and other nations.  Affected banks and their customers.

Leading up to the Great Depression…  In October, the market collapsed, and there was no money to pay what was owed on the margin.  Businesses failed, unemployment skyrocketed, and loans borrowed from banks could not be repaid.  Bank customers tried to withdrawal all their money at once (bank run).  The banks’ reserves dried up and couldn’t cover all the liabilities.  Depositors in most of the failed banks completely lost their money.  Roaring (economic) 1920s made stock market attractive to many.  People and companies borrowed money to buy stocks on credit.  Many stocks were bought on margin, meaning for a fraction of their price.  Stocks were resold at a profit without the full purchase price of the stock ever having been paid.  This led to risky investments and speculation.  Market fell in September  People tried to dump their stocks out of panic.

 On March 6, 1933, President Franklin D. Roosevelt declared a bank holiday.  He closed all banks by proclamation to save the remaining assets of banks still in business, allowing people to calm down.

C. Banking Acts (1933 and 1935) Emergency Banking Act of 1933  Also called Glass-Steagall Act  Massively reformed nation’s banking system 1. Separated commercial banking from investment banking. (protect assets) 2. Required bank holdings to be examined by Federal Reserve. 3. Established Federal Deposit Insurance Corporation (FDIC)

 Federal Deposit Insurance Corporation (FDIC): guarantees deposits against bank failures up to specified limits.  Currently up to $250,000 per depositor, per account

Banking Act of 1935  Expanded the monetary controls of Federal Reserve by changing the Federal Reserve Board.  Secretary of Treasury and Comptroller of Currency were removed.  The board member terms were lengthened.

CHECKPOINT What brought about the creation of the Federal Reserve in 1913?  Problems with the money supply caused by practices of large numbers of unregulated banks. What is a bank run?  Occurs when all depositors want their money at once.

II. MODERN BANKING  Banking system remained unchanged for the rest of the 20 th century.  Changes in Federal Reserve fine-tuned the system.  Reserve and chairmen became more independent of government.

A. Inflation and Banking  Inflation: collective rise in money supply, incomes, and prices.  Causes money to have less purchasing power.  Stagflation: combination of a stagnant economy and high inflation.

 Banks changed in 1970s and 1980s because of inflation.  Prices, wages, and interest rates rose rapidly.  Caused by excess of easy credit and money.  (other struggles) Banks were restricted in how much interest they could pay out, making other options more attractive to depositors.  Inflation was rising, economy was falling, creating stagflation at almost 13% per year.  Federal Reserve tightened money supply and allowed interest rates to rise (to combat inflation).  A severe recession followed, but inflation fell.  Made room for growth for the 1990’s.

Look on page 48…

A. Deregulation Advantages  Allowed banks to compete more freely in open market.  Opened doors to services available today. Disadvantages  Financial institutions were allowed to make unwise loans.  Risky investments and speculation led to S & L failures.

CHECKPOINT Why is inflation a potentially serious economic threat?  The value of money declines; more money buys less. Why were banks deregulated in the early 1980s?  To allow them to compete more efficiently for customers.

Works Cited CCCCenter for Financial Training. Banking and Financial Systems. Mason, OH: Thompson South-Western, 2003.