When Great Banks Close their Doors

A "run on the banks" is not something confined to the history books of the 1930s, by any means. We have seen it in Argentina and other countries in recent years.

On September 14th, 2007, the shares of Northern Rock in the UK plunged 25%... "long lines of customers have formed outside several Northern Rock branches around the UK"

This followed the news that Britain's financial authorities had stepped in to rescue Northern Rock "as the group, which has lent aggressively to home buyers, fell victim to the sharp rise in borrowing costs between banks."

"Judging by the length of the queue, I'm going to take everything out... I wish I'd buried everything in the back garden in a big hole" said one man, interviewed on BBC radio.

Many people will have seen the following historic and famous photo, which, according to an article from the Winston-Salem Journal, hangs on the wall at a day-trading company in Winston-Salem to warn people to "keep things in perspective".

With few people left around who directly remember the real human tragedy of the 1930s, what might happen when the lessons of the past are ignored?

Consider the implications of the recent repeal of those depression-era laws, such as the 1933 Glass-Steagall Act. Was this necessary to allow the creation of ever-larger banks ("too big to fail?") whose merged entities would have fallen foul of Glass-Steagall? But this act was put in place by the US Congress in order to prevent a repeat of the 1929 crash. Isn't it perhaps reckless to take away the safeguards? Are conditions today that much safer than in 1929?

Contributing to the 1929 crash was lax regulation of companies where investors were susceptible to fraud and hype. It was said that "Individuals did not know whether companies were doing as well as they claimed to be doing and whether companies' financial reports were reliable". Haven't we seen a repeat of this kind of thing in the spread of "pro-forma" accounting, where losses (according to generally accepted accounting principles) are automagically transformed to profits, and company results famously beat the Street by precisely one penny- time and time again? Hype is back with a vengeance- what market observer has not heard the new expression "pump-and-dump" (I wonder what the equivalent expression would have been in 1929)?

Haven't we seen, in Enron, the modern-day version of lax regulation, where financial transactions are hidden in derivatives and entities that do not show up on the books that the auditors see? And what of investors' confidence in companies such as Arthur Anderson, tainted by Enron-itis? And Allied Irish, where internal supervision procedures do not seem to have benefited from the lessons of Barings?

After the 1929 stock market crash, 4,000 banks failed because depositors, having suffered a loss of confidence in the system, rushed to withdraw their savings which they perceived to be at risk.

Can people in the G7 world imagine that what happened in Argentina not long ago could not happen to them? The key word is confidence, and that is all that supports the money system of today.

In 2002, Japan moved into more dangerous territory by removing guarantees for fixed-term deposits at banks. A Yahoo! news report stated:

"Nobuyuki Kudo, vice president of Ace Koeki's Research Division, said the stage for February's surge in gold buying was set by the Japanese media, which for the past year has warned of a possible run on banks after the government abolished its blanket guarantee for fixed-term deposits April 1st . In fact, investment demand for the yellow metal exploded to 25 metric tons in February from 10 tons in January...

"The problems ailing the Japanese banks are far from being solved, and investors will remain nervous about their money with the abolishment of full guarantees for checking and regular savings accounts taking effect next year. So you might still see some sudden surges in demand whenever the Japanese media decides to start talking about the next financial crisis," said Kudo."

WHEN THE GREAT BANKS OF AMERICA CLOSED THEIR DOORS
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Here are anxious crowds gathered outside the doors of a branch of one of the large United States banks that failed in December, 1930. The numerous bank failures led to the passing of stricter banking laws.

Congress thought, in 1933, that the Glass-Steagall Act would ensure that such a tragedy would never be repeated in America. Little did they know, that in the closing stages of the 20th Century, that their work would be thrown away to help prop up mega lame-duck businesses whose only hope of survival was to get "too big to fail".

Banks are supposed to invest their depositors' funds in low risk business ventures or securities. If a bank has an inside opportunity as a stockbroker to influence the market for the securities in which the bank has a position, we have a conflict of interest that is clearly not governed by the laws of competition or fairness, and tends to inflate the value of assets without requiring them to earn that value through genuine strength or soundness of business. And if the only way to survive is through being big, where are tomorrow's great businesses going to come from, as "great oaks grow from little acorns"?

The following story emerged in 2002 of a clear and astounding "conflict of interest" at Merrill Lynch:

"The emails, made public by New York State Attorney General Eliot Spitzer, reveal that while Blodget and other Merrill analysts were pumping up Internet stocks in research reports and in television appearances, they were saying something quite different in private - in some instances referring to highly recommended stocks as ''crap'' and ''junk.''

Spitzer says the emails are proof that Merrill's analysts maintained high ratings on many companies simply to help the firm secure more investment-banking work..."

Bad advice suit rocks Wall Street [Apr 20, 2002] "What does a sharemarket analyst do about a share that's "a piece of crap"? Recommend it to his clients. That is what analysts at the giant US brokerage Merrill Lynch did repeatedly, charges a lawsuit by New York Attorney-General Eliot Spitzer..."

A load of bull [Apr 14, 2002] "There are inherent conflicts every minute of the day," says one American banker."

Independent research? Do me a favour " "It's a sell," said the analyst. "They are one of the most active players in M&A," said the corporate financier. "We want their business. Get with the programme"... " - The Independent on Sunday, 14 April 2002

Merrill hit by claim of duplicity [Apr 10, 2002] "Attorney general alleges analysts' recommendations did not accord with private view of stocks"

Merger mania results in the creation of a small number of very large organisations. Despite their ability to move the markets because of their size, large organisations remain vulnerable- as demonstrated by Enron. As "too big to fail" organisations, they have to be propped up and this allows unsound business to be perpetuated, and robs the taxpayer or the sound businesses from which the propping-up resources are taken. Ultimately this will mean that the day of reckoning is merely put off and will have more devastating consequences- which can hardly be in a nation's interest.

A SCENE DURING THE TRADE DEPRESSION OF 1930

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Above is a portion of one of the "bread lines" that had already become necessary in American cities by the autumn of 1930. As the depression dragged its weary length from month to month and from year to year, more and more money was required for unemployment relief. Private charity, local funds, even state funds, were insufficient, and at length Congress had to appropriate huge sums to keep people from starving.

Could such measures one day be needed again?

According to the UK Copyright Act 1911 the copyright on photographs such as this was limited to 50 years from the date they were taken and has now lapsed.

  Updates: July 13, 2003; January 4, 2004; March 29th, 2006, Sept. 14, 2007.