Bank Fragility, “Money under the Mattress,” and Long-Run Growth U.S. Evidence from the “Perfect” Panic of 1893

1. Bank Fragility, “Money under the Mattress,” and Long-Run GrowthU.S. Evidence from the “Perfect” Panic of 1893 Carlos D. Ramirez George Mason University FDIC’s Center for Financial Research

2. Finance-Growth Nexus: A debate with a long history… • Schumpeter: “The banker…authorizes people, in the name of society as it were, to…[innovate]” (Theory of Economic Development, 1911) • Joan Robinson (1952) argues that finance simply responds to growth.

3. Question still being investigated… • Kroszner, Laeven, and Klingebiel (2005); • Dell’Ariccia, Detragiache, and Rajan (2005); • Bonfiglioli and Mendicino (2004); • Levine (2005); • Rajan and Zingales (1998), etc.

4. Objects of this paper: • 1. Estimates interstate growth regressions to examine the impact of bank failures and banking organization on long-run growth. • 2. Provides a simple, intuitive framework for understanding how or why bank failures can affect growth in the long run.

5. Details on Objective 1: • Quantifying the extent to which the panic affected long-run growth • I do it via standard Barro-style convergence regressions, where the dependent variable is a state’s growth rate and the independent variables includes a measure of failed deposit assets, along with the typical other variables (initial income, education, etc.)

6. Why 1893? • It happened a long time ago--useful for understanding its long-run consequences. • Panic was very severe. Lots of bank failures. • Output contraction was very severe--2nd only to the Great Depression. • Incidence of bank failures varied significantly among states--allows for identification of effects. • Bank failures were not directly caused by local adverse economic conditions--mitigates possible endogeneity problems. • No federal government response that may “contaminate” the results.

7. Basic Results

8. Are coefficients meaningful?

9. What does it all mean? • States that experienced more banking failures (whether temporary or permanent), grew less rapidly, certeris paribus. • The effect of bank disintermediation is nearly as large as that of eliminating geographical restrictions in banking.

10. Standing back for a second… • Literature that studies the effects of banking crises on economic activity focuses on short-run effects. • Here I am arguing that there may be long-term effects as well. • What may explain these long-term effects?

11. Now, looking at Objective 2: • Depositors do not know if or when they will get their money back from a closed bank. • Bank closures (temporary or permanent) induces a reaction from ALL depositors. • With bank failures, depositors lose confidence on banking system. • Prefer to keep the money “hidden under the mattress.” • If this becomes “institutionalized” it will affect LR growth.

12. Looking for more evidence: comparing WV and NE • Why is this comparison interesting? • WV did not see a single bank failure during the 1893 panic, even though it was a very poor state. • NE experienced the second highest bank failure rate in terms of deposits. It was the first in terms of bank failure rate. • So it is like comparing the best with the worst.

13. What do we see?

14. Evidence for portfolio (de-) composition • Survey evidence: • Czech Republic survey on March 2003: 75% of population do not trust banks. • Argentina, 2004, a survey done by American Express, reveals 86% population do not trust banks. • The Moscow Times reports in 2004 that approximately 70% of population do NOT have bank accounts!

15. US bank in the 1890s? • Evidence presented is for modern times. • Imagine what it must have been like back in the 1890s… • Some evidence: newspapers

16. Some newspaper evidence • Chicago Daily Tribune, March 21, 1895: Indiana “miser” dies with about $15,000 in gold and cash hidden around his house. (nearly $400,000 in today’s dollars.) • New York Times, May 17, 1897 reports: “Mr. Bissel, a farmer, having no faith in banks, kept his money hidden about his farm…The other day he hid it up in flue. The next day his wife put up a stove and started a fire and burned up $3,000 in bank notes.” • New York Times, Nov. 1, 1901 reports: “Jacob Nickelson, who lives near Hyndman, did not believe in banks, and kept his money hidden in his house. Yesterday robbers stole $4,500 in greebacks.” • Washington Post, June 25, 1905 reports: “The bank commissioner of Kansas is quoted as saying that while there is no way of getting accurate figures, he has reason to believe that there is as much money hidden in socks and under carpets or buried or carried as is on deposits, and Commissioner Royce, of Nebraska, agrees with his opinion….”

17. Time Series Evidence… • Pictures and articles are suggestive, but inconclusive. • Need more “hard” evidence. • Look at newspaper articles more closely. • Downloaded ALL newspaper articles between 1860 and 1970 that had the words: “money hidden.” • Majority of articles are tales of people losing their wealth in fires, robberies, accidents, etc.

18. Newspaper evidence… • Search produced 641 articles. • Look at the incidence of articles over time:

19. “Money Hidden”—Results:

20. Allowing of Lagged Dep. Vbl:

21. Conclusion • The amount of disintermediation caused by bank failures and bank panics can be quite substantial. • The effect of disintermediation can go beyond the standard short-run “credit crunch” stories. • Disintermediation, without some sort of policy intervention aimed at restoring faith in the banking system, can have long-term consequences for growth.