When a Bank Fails, There’s Always a Villain

The U.S. used to have more than 30,000 banks, most of them serving just a single community. Two centuries of failure and lost deposits suggest smaller isn’t always better

By Jason Zweig of The WSJ. Excerpts: 

"Years ago, banks were regulated at the state, not the federal, level."

"Back in 1809, the Farmers Exchange Bank of Glocester, R.I., became the country’s first notable bank failure. What made it newsworthy wasn’t its size; it was minuscule. But the tiny bank had borrowed $800,000, or 4,000 times its total capital, according to the late financial historian Bray Hammond, who called it a “musical comedy bank.” Farmers Exchange issued debt and showered money across New England at an ever more-frantic pace until it went bust.

In those days, the government didn’t print money; banks did. When they lent or borrowed too aggressively, the result was a bank panic, as in 1819, 1837, 1839 and 1857. 

Even after the federal government took over issuing the nation’s money during the Civil War, panics erupted in 1873, 1884, 1890, 1893 and 1907. 

Sometimes the fuse was lit by small banks, sometimes by big ones, although losses to depositors typically were fairly small and the damage fleeting."

"Andrew Jackson called the Second Bank of the United States a “death blow to our liberty” before he finally succeeded in squelching the central bank in the 1830s.

The distrust of big banks helped lead to massive proliferation of little ones. By 1896, the U.S. had 12,112 banks—nearly all operating in only one state, most without any branch offices.

Yet in 1907, it was the biggest banker of them all, J.P. Morgan himself, who intervened to avert panic. That fall, the Knickerbocker Trust Co. failed, setting off withdrawals of more than $200 million—or some $40 billion in today’s money. Morgan hastily assembled a consortium of banks that bolstered major firms, calming depositors."

"The U.S. reached an all-time peak of 30,456 banks in 1921. 

Then came a wave of farm failures in the 1920s and, even more devastating, the Great Depression. 

The biggest mass die-off in banking history ensued."

"Total deposits at U.S. banks shrank to $41.7 billion in 1933 from $58.3 billion in 1929. Historians estimate that depositors at the failed banks lost, on average, as much as 25% of their money.

Federal policy makers viewed the crisis as evidence that “there was too much competition in U.S. banking,” says Richard Sylla, a financial historian at New York University. 

The New Deal imposed reams of regulation that, among other provisions, barred commercial banks from underwriting stocks and bonds."

"From 1990 through 2019, the share of total U.S. banking assets controlled by the 25 largest banks has doubled to 68%, according to a 2020 study by economists Caroline Fohlin of Emory University and Matthew Jaremski of Utah State University. Over the same three decades, the five biggest banks tripled their market share, controlling 45% of all assets.

A century ago, the 25 largest held a combined total of less than 16% of all bank assets, with the top five holding below 6%.

The costs of complying with regulation, especially the complex Dodd-Frank law of 2010, are one reason the U.S. has lost roughly a third of its independent banks since 2008, says Prof. Sylla."