Gary Gorton on Financial Crises

I get the impression from your selection that financial crises aren’t unusual?

Yes. The idea of the selection is that most people are very unfamiliar with financial crises. There might be some older people who lived through the Great Depression but they would have been children at the time. Today’s crisis seems like a unique event, but in the US and in the UK crises were very common events. The idea here is to try to show people that we have a history of these things and a history of similar responses. There is a structural reason for crises: banks create very useful liabilities (like checks and repo), but they are vulnerable to runs.

The New York Press book is a compilation of popular accounts of the crises assembled by the press. There are poems, jokes and articles about those pre-Civil War crises – there is everything here. They were correct in putting the 1837 and 1857 panics on the cover as they were the important panics prior to the Civil War. So, this book was written after 1857, looking back and saying: ‘Look! We’ve had all these other panics – 1690, 1748, 1780…’ The idea is similar in a way to my idea – pointing out the precedents in history.

So, we really haven’t learnt much.

Well, I think the first thing to learn is that these events are not so unique, that you don’t have to have specific policies for each event, that there is a commonality which is to do with how banking is structured. Before the Civil War banks printed their own money – bank notes represented the each bank’s private money. The problem then was that people could run en masse on banks demanding their money back. In 1837 the Free Banking Act was passed in New York State which required banks to back their note issue with state bonds. But, these bonds were risky so it did not prevent panics. During this period checking accounts grow significantly. Then, after the Civil War the government takes over the money supply. The problem is no longer runs on private bank notes, but from 1857 until 1934 there were repeated panics to do with checks: everyone demanding to withdraw all their money from their checking accounts. We finally get deposit insurance in 1934 even though there was a lot of opposition, including economists. Roosevelt was also not a proponent.

Sprague, the author of the History of Crises, was the first chaired Professor at Harvard Business School and his book is a classic narrative of the national banking era. So, during the Civil War the government passes an act which charters national banks: 1865-1914 is the national banking era. All the panics in this era are to do with checking accounts. Then, in 1914, the Fed comes into existence and the next panic, of course, is the Great Depression.

So, we have made some progress. The current crisis isn’t as bad as the Great Depression. The Studs Terkel book, Hard Times, is an oral history of the Great Depression, including people from all walks of life describing what they did, from the demonstrations and riots of the out-of-work to Goldman Sachs executives talking about what’s going on. Studs Terkel was a Chicago radio host and he recorded all these interviews long after the Depression and played them on the radio in the 1970s. There are interviews with people who spent the time as hobos, people from the Works Progress Administration. There was 25 per cent unemployment in the Great Depression, whereas now it’s ten per cent. So, there is a group of people, like you and me, who are doing fine and then a large group of invisible people who aren’t doing fine.