Chapter 19
The Bank Holiday
On a hot summer day, with dark circles under his eyes, Federal Reserve Chairman Sheppard appeared before a select group of the press corps. With only a hint of emotion and a solemn expression, he announced:"In order to foster a more equitable distribution of the damages wrought by the financial turmoil of recent months, I will impose a temporary suspension of FDIC payments to depositors. At the same time, to cool down the pressures on derivatives, we are declaring a temporary holiday for the withdrawal of bank deposits."
Normally, reporters would have jumped to their feet, hands raised anxiously, jockeying for position and shouting questions. Instead, the sole response was stunned silence. A holiday? That was expected by some. But a "temporary suspension" of FDIC payments?
The AP correspondent stood slowly and asked deliberately: "Mr. Chairman, I sense in your statement a contrast between the temporary nature of the holiday and the indefinite, perhaps permanent, nature of the suspension of FDIC payments. Was that contrast intentional? If so, what does it really mean for the savers of this country?"
The reporter from the Wall Street Journal popped up almost simultaneously with a similar question: "What are the consequences, in dollars and cents, of your comment regarding the 'more equitable distribution of damages'?"
The Chairman's expression became even more solemn than before. "In past crises, the damages wrought upon this nation by the financial crisis have fallen almost entirely upon the shoulders of those savers and investors who have entrusted their hard-earned funds directly to the Treasury Department of the United States of America via government bonds. They were wise enough to invest in the very safest security of our land. And yet, they were penalized by declines in the market value of their investments. Since they could not afford to sell these bonds at a price that substantially reduced their capital, they were, in effect, locked out of their savings � savings they desperately needed to pay their mortgages, their overhead, their business debts.
"Meanwhile," the Chairman continued, "those Americans who deposited their money in the nation's banks � institutions that are known by all to be involved in high-risk derivatives and venture capital operations to high-techs or dot-coms � have been protected. And those savers who sought to get the most yield for their money, ignoring the implied risk, have been sheltered. In order to maintain this fiction � this unnatural imbalance � our Treasury has had to drain its cash resources, our central bank has had to flush the banking system with paper money, and our entire future as a nation has been jeopardized.
"This inequity can continue no longer. The time has come to let the true values flow to the true investors in those values; and to let the true losses be shouldered by those who took the true risks. Truth and equity � rather than deception and fantasy � must be the underlying principle through which this crisis is finally resolved."
This answer once again left the reporters stunned. Slowly at first, but then in a flash of images, the audience finally realized what had just happened. One columnist later described his thoughts as follows:
I sat there, frustrated by the Chairman's use of philosophical concepts, struggling desperately to decipher the real meaning of what had just transpired. Suddenly, a scene flashed across my mind of my grandmother sitting before a bank officer. She has come to the bank to withdraw her life savings of $25,000. But instead, he hands over less than $8,000, which supposedly represents all the money due her at that time."
"Oh my God," I thought to myself. "The Chairman just said that the depositors in this country will take the rap for the banks' losses. They're only going to get so many cents on each dollar, depending on the actual market value of the banks' portfolios. The Fed is going to actually liquidate the assets of the banks wherever necessary. This is worse than the 1930s! Much worse!"
Most economists could not understand why it happened. Yet, if you looked at the numbers on the derivatives, you could see the reasons clearly. Most of America's largest financial institutions had taken too many risks, made too many poor investments.
When those investments went bad during an economic decline, they lost money. And when the word got around to depositors, they tried to take their money out, which, for the most part, was unavailable either from the bank or the federal insurance companies. You didn't have to have a Ph.D. in finance to figure that one out.
Now, with the truth obvious to everyone, the mood turned from the extreme complacency of the pre-panic period to excessive negativism. Americans felt that it was "the worst disaster of all time" and that they could "never" recover.
But with a broader vision of history, they might have realized that it could have been a lot worse. In fact, looking back at those final, climactic days of the Great Stock Panic, we can see many positive elements, the importance of which was not fully appreciated at the time.
First and foremost was the fact that, although hard to come by, paper money still had solid value. This was infinitely better than the crisis that had befallen Germany after World War I when it took 3 trillion marks to buy one US dollar.
Second, America's technological and industrial infrastructure was still strong � quite the opposite of post-Soviet Russia.
Third, unlike Japan, America was not choking in a vice of government regulations, although excessive controls in some US industries was certainly a major issue.
Fourth, at the banks, although most people said that "the doors of the banks and S&Ls; were closed," they weren't actually closed. What it really meant was that there was a freeze on most deposits. Meanwhile, most other bank business continued. The banks' trust departments and custodial services were largely uninterrupted. Your safety deposit box was immediately accessible. And although some check cashing on NOW accounts was blocked, all commercial check clearing was maintained. Most important, payouts to checking accounts from the Treasury Department were kept inviolate.
Fifth, checks drawn on Treasury-only money funds also emerged as one of the shining stars. Unlike some other drafts, they were accepted and even actively sought after by individuals and businesses anxious to sell their products. In the days following the Fed Chairman's announcement, if you wanted to buy an item at your local appliance outlet and offered to pay with a personal check, you'd initially encounter extreme reluctance. But if you mentioned that it was a money-fund check, the clerk would pull out a list of "good money funds." As long as it was on the list, he'd honor it. And as long as your money fund invested solely in Treasury securities, it would be on the list. The same occurred at supermarkets and shopping malls throughout the country.
The liquidation of bad bank assets and the distribution of each bank's losses according to their actual market values, as painful as it was, did not doom the nation as a whole. Rather, it forced each citizen and each corporation to make the sacrifices necessary to restore the economy. In response, Americans of all income strata had to lower their living standards, work harder and cut costs.
One Senator who was absolutely opposed to the idea changed his views and described it this way in a speech at the Debt Hearings: "If you're on the roof of a house that's consumed by flames, you have two choices. Either you face certain death by fire, or you jump and endure the broken bones. Any further attempt to prolong the banking disaster would burn the whole economy to the ground. We chose to jump. It was the only way out."
In response, one spectator shouted out from the Senate gallery: "Is it only a one-story building that's burning? Or is it a towering inferno?" The answer wouldn't be known for many months.
Despite the freeze on withdrawals, new mobs of depositors lined up at their banks' doorsteps. Again, the nation was thought to be on the brink of chaos.
Less than twenty-four hours later, the spreading paralysis forced the President of the United States to take the last and final step. He declared a temporary halt to most nonessential production, distribution, and financial transactions � a banking, production, and market holiday.
For the astute investors, the days preceding this declaration turned out to be the last chance to buy common stocks at the bottom of the greatest bear market in history.
To most Americans, however, it seemed as though the US economy had come to a screeching halt from which it could never recover.
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