Herbert Hoover: On Bank Liquidity and Solvency, 1931

This is excerpted from the American Presidency Project at UCSB. Hoover writes the following letter to George L. Harrison, Federal Reserve Board of New York, on financial and economic problems on 5 Oct 1931:

Dear Mr. Harrison:

The request which I laid before the leading New York bankers last night for cooperation in unity of national action to assure credit security can, in the light of our discussion, be simplified to the following concrete measures:

1. They are to take the lead in immediate formulation of a national institution with a capital of $500,000,000. The function of this institution to be:

(a) The rediscount of bank assets not now eligible in the Federal Reserve System in order to assure the stability of banks throughout the country from attack by unreasoning depositors. That is to prevent bank failures.

(b) Loans against the assets of closed banks to enable them to pay some early dividend to depositors and thus revive many business activities and relieve many families from destitution.

2. It is proposed that the capital be underwritten by the banks of the United States as a national effort, possibly with the support of the industrials. New York being the financial center of the nation must of necessity assume both the initiative and the major burden. The effort should be participated in by the country at large by appropriate organization.

3. As I said last night, we are in a degenerating vicious cycle. Economic events of Europe have demoralized our farm produce and security prices. This has given rise to an unsettlement of public mind. There have been in some localities foolish alarm over the stability of our credit structure and considerable withdrawals of currency. In consequence bankers in many other parts of the country in fear of the possibility of such unreasoning demands of depositors have deemed it necessary to place their assets in such liquid form as to enable them to meet drains and runs. To do this they sell securities and restrict credit. The sale of securities demoralizes their price and jeopardizes other banks. The restriction on credit has grown greatly in the past few weeks. There are a multitude of complaints that farmers cannot secure loans for their livestock feeding or to carry their commodities until the markets improve. There are a multitude of complaints of business men that they cannot secure the usual credit to carry their operations on a normal basis and must discharge labor. There are complaints of manufacturers who use agricultural and other raw materials that they cannot secure credits beyond day to day needs with which to lay in their customary seasonal supplies. The effect of this is to thrust on the back of the farmer the load of carrying of the nation’s stocks. The whole cumulative effect is today to decrease prices of commodities and securities and to spread the relations of the debtor and creditor.

4. The only real way to brake this cycle is to restore confidence in the people at large. To do this requires major unified action that will give confidence to the country. It is this that I have asked of the New York bankers.

5. I stated that if the New York banks will undertake to comply with this request, I will seek to secure assurance from the leaders of appropriate committees in Congress of both political parties to support my recommendation at the next session for

(a) The extension of rediscount eligibility in the Federal Reserve System.

(b) If necessity requires to recreate the War Finance Corporation with available funds sufficient for any emergency in our credit system.

(c) To strengthen the Federal Farm Loan Bank System.

Yours faithfully,

HERBERT HOOVER

[Hon. George Harrison, Federal Reserve Bank, New York City]

I found these parts of the response from Harrison informative as to what the banking problems in 1931 were:

Immediately after our return from Washington on Monday morning a committee of New York bankers was appointed to consider your proposal. They authorized me late Monday afternoon to tell Mr. Mills (a) that they were prepared to support your suggestion to the bankers of the United States to form a corporation of $500,000,000 for the purpose of making funds available to banks requiring accommodation upon the basis of sound banking assets not now legally eligible for rediscount at the Federal Reserve Banks; (b) that, as requested by you, they would assume the leadership in the formation of such a corporation; and (c) that the twenty four members of the New York Clearing House Association would no doubt agree by the next day to contribute their share by pledging $150,000,000, which is approximately two percent of their net demand and time deposits. This they have since done, as I informed you late yesterday afternoon…

[…]

…In this district, where I happen to be more familiar with the situation than in other sections of the country, the principal cause of bank failures has not been a lack of liquidity but rather insolvency caused by need for a drastic write-off in bond portfolios. In other districts, I understand, many banks are threatened with insolvency because of losses in real estate loans as well as bonds.

So, while the proposed corporation will do much promptly to provide liquidity for certain solvent institutions needing cash, thus avoiding the forced sale of their assets at substantially depreciated values, it will not unfortunately be able to aid materially in improving the banking situation in those districts where the principal difficulty is the threat of insolvency through depreciation of bond or real estate values. The country banks in this district, and I believe it to be the case also in the Boston and Philadelphia districts and perhaps to a lesser extent elsewhere, have their resources very largely employed in bonds. Indeed, outside of half a dozen of our larger cities, nearly fifty percent of the assets of the banks in this district are in bonds. The proposed corporation will be helpful in this situation to the extent that it relieves some of the selling pressure upon the bond market. But if the bond market is not substantially bettered very promptly the country banking situation in this district, and possibly in other districts as well, will still remain a critical problem.

[…]

The problem of those banks which have suffered large losses on mortgage loans is perhaps even more difficult of solution than that of those with large losses in their bonds. The suggestion you made on several occasions last week with reference to a possible mortgage rediscount system, if feasible, might ultimately prove of real relief in that regard. But even if the real estate problem is not capable of immediate solution, there is no reason on that account alone to delay whatever constructive steps might be taken with respect to bond values, an improvement of which would also indirectly affect the value of other bank assets.

I hope you will please forgive my bothering you with such a lengthy letter, but I feel that you have already taken such an important and helpfully constructive step looking towards the correction of a very substantial part of the problem, that I would not be frank with you if I did not point out the very real need for fundamental improvement in the condition of a great many banks now threatened with insolvency and failure because of capital impairment through the severe depreciation of their assets–whether based on bonds or real estate.

Faithfully yours,

GEORGE L. HARRISON

[Hon. Herbert Hoover, The White House, Washington, D.C.]

Source: 334 – Letter to George L. Harrison, Federal Reserve Board of New York, on Financial and Economic Problems – The American Presidency Project, UCSB