March 16, 1933 - The Chicago Plan Memorandum
On March 4, 1933 Franklin Delano Roosevelt was inaugurated as the 32nd President of the United States of America. The next day, March 5, 1933, FDR declared a “Bank Holiday” closing all banks in the country beginning the next morning, Monday, March 6. The following Sunday, March 12, 1933, FDR gave his first “Fireside Chat” in which he outlined the schedule for reopening banks. Following certification by the Secretary of the Treasury upon recommendation from the Federal Reserve Banks member banks in twelve Federal Reserve Bank cities were the first to reopen the next day, Monday, March 13, 1933. The following day, March 14, member banks in another 250 cities reopened.
In 1921 there had been 506 bank failures. For the decade of the 20’s the average was about 600 per year which was ten times greater then the preceding decade. The great banking crisis of the early 30’s came in 5 significant waves. 806 banks failed from Nov-Dec 1930. Another 573 failed from Apr-Aug 1931. In Sep-Oct 1931 another 827 banks failed and during the June-July 1932 time frame 283 closed their doors. According to the FDIC website yearly bank failures were:
1929 – 659
1930 – 1,350
1931 – 2,293
1932 – 1,453
1933 – 4,000
By the time FDR entered office and declared the national bank holiday every state in the union had individually declared their own bank holidays beginning with Nevada in Nov.1932. Many of the 4,000 banks that failed in 1933 simply never reopened following the national bank holiday and the required certification process.
On March 16, 1933, a memorandum signed by 8 economists at the University of Chicago was sent to then Secretary of Agriculture Henry A. Wallace. This memo along with a modified version of it the following November formed the basis of what became known as ”The Chicago Plan.” For those who have followed my recent diaries it won’t surprise you to learn that my grandfather, Garfield V. Cox, was one of the eight signers.
THE UNIVERSITY OF CHICAGO
Department of Economics
March 16, 1933.
Hon. Henry A. Wallace,
Secretary of Agriculture,
Washington, D. C.
Dear Mr. Wallace:
During the past week, we have tried to formulate and agree upon a specific program which would provide, both for emergency relief, and for permanent banking reform. The results of this effort are contained in the five-page statement which we enclose. This document is strictly for your private use; and we request that every precaution be taken against mention of it in the press.
The program defined in the statement is one which we believe to be sound, even ideal, in principle. What its merits may be, in the light of political consideration, we frankly do not know. We are sensible, moreover, of an obligation not to broadcast publicly any statement which might impair confidence in Administration measure, or impair their chances of successful operation.
On the other hand, we feel that our statement may deserve thoughtful consideration, among people of interests like our own; also, that it may suggest measures which might usefully be incorporated in other, and perhaps less impractical, schemes. Moreover, most of us suspect that measures at least as drastic and “dangerous” as those described in our statement can hardly be avoided, except temporarily, in any event.
Please feel free to use the document in any manner consistent with complete avoidance of newspaper publicity. If you feel disposed to send us your comments, favorable and adverse, upon the proposals, we shall be grateful indeed for your cooperation. Communications may be addressed to any member of the group.
Sincerely yours,
G. V. Cox F. H.Knight
Aaron Director L. W. Mints
We hope you are one of Paul Douglas Henry Schultz
the forty odd who get A. G. Hart H. C. Simons
this who will not think
we are quite looney, I think By Frank H. Knight (Sgd. )
Viner really agrees but doesn't
believe it good politics. F.H.K.
Note: “Viner” referenced in the side note was another University of Chicago economist,
Jacob Viner, a good friend of my grandfathers, who worked in various positions in the Roosevelt administration primarily as an advisor to
Henry Morgenthau but I think originally as a representative to the Economic Committee of the League of Nations.
I don’t have the economic background to do justice to their proposal so I hesitate to write this piece. However, I find the ideas interesting and provocative enough that I felt it worth while to put them out there for thought and discussion. I welcome economists or those with more of a financial background to add to or correct me in the comments. A vastly more expert view of the plan can be found in Professor Ronnie Phillips paper here.
The Chicago Plan was not adopted. As hinted at in the official letter, “measures at least as drastic and “dangerous”,” and in the side comment “think we are quite looney,” the proposals were considered radical even by those proposing them.
It is evident that drastic measures must soon be taken with reference to banking, currency, and federal fiscal policy. In such a situation, it seems desirable that there should be some statement of opinion by academic economists, especially by groups whose members hold substantially similar views. We therefore submit the following general recommendations.
(a) That further decline in the volume of effective circulating media be prevented, preferably by some sort of federal guarantee of bank deposits;
(b) That guarantee of bank deposits be undertaken only as part of a drastic program of banking reform which will certainly and permanently prevent any possible recurrence of the present banking crisis;
(c) That the Administration announce and pursue a policy of bringing about, and maintaining, a moderate increase (say, of -and not to exceed -fifteen per cent) in the level of wholesale prices, pending later adoption of some explicit criterion for long-run currency-management.
“Circulating media” meaning essentially “money.” I’ve seen one estimate that by this time in 1933 the amount of money circulating in the U.S. economy had declined as much as 40% since the crash of 1929.
One of the major outcomes of various banking reforms of the early 1930’s was the creation of deposit insurance. What we know today as the FDIC was created at this time. This letter was not the sole support for it but was a contributing factor. As we’ll find out below this is not exactly the outcome these economists were looking for. Though here they do talk about the “guarantee of bank deposits.”
In regard to point C, in general when the value of money rises there is a corresponding increase in what can be purchased with it. In general this means a decline in prices. With 40% less “circulating media” the value of the remaining 60% increased and prices declined drastically. One of the major beliefs of economists at the time was to achieve a stable price level and a stable value of money. I am way out of my depth speaking on this particular topic but throughout my grandfathers papers and throughout the several decades in which he wrote it is clear that achieving this sort of stability and avoiding inflation is a major policy goal. In this case he wants to reverse a previous deflation and return to price levels of pre-crash 1929. I’m going to focus my attention on parts (a) and (b) and not (c) though they are clearly intertwined.
Now let’s get specific and let’s get radical…
It seems appropriate to translate these general recommendations into more detailed proposals. The proposals below are admittedly inadequate and tentative at many points; but they should serve to define what we conceive to be objectives of sound policy:
(1) That the federal government immediately take over actual ownership and management of the Federal Reserve Banks;
(2) That the Federal Reserve Banks should guarantee the deposits of all Members Banks which were open for business on March 3rd, 1933 (or on the last day preceding any moratorium then in effect), the Reserve Banks being granted full supervisory control over the management of these institutions;
(emphasis theirs)
The government should take control of the Federal Reserve Banks. The Federal Reserve Banks should guarantee the deposits of all member (private commercial) banks. And the Federal Reserve Banks now under the direct ownership and control of the government should take supervisory control of the private commercial banks.
Not exactly, but pretty darn close to saying… nationalize the banks. If you think perhaps I overstate the case a little further down…
The precise technique of control, exercised by the Reserve Banks over the guaranteed institutions, should be left largely to the decision of the Reserve authorities. The powers, however, should be broad. The Reserve Banks should be free to take over, in return for Reserve Notes, such assets of Member Banks as they might need, as basis for note-issue, or for their open-market operations.
And, even further…
(6) That the Federal Reserve Banks be instructed, over such period as may prove necessary for orderly liquidation, to dispose of all assets of the Member Banks, to pay off all deposit liabilities, and upon final settlement with the stockholders to declare the corporations dissolved;
In case you are wondering, these guys were definitely not communists or socialists. Quite the opposite in fact. These guys were anti-Keynsian precursors to Milton Friedman who credited Knight and Viner in particular as the founders of the so-called Chicago School of economics.
So if we have the government take direct control of the Federal Reserve Banks and dissolve the private commercial banks what do we do then?
(7) That banking legislation be enacted providing for incorporation of a new kind of institution.
(a) which alone shall be entitled to accept funds subject to check or to payment on demand;
(b) which shall be required to maintain reserves of 100 % in lawful money and/or deposits with the Reserve Banks;
(c) which shall serve exclusively as institutions for deposits and transfer of funds;
(8) That additional legislation be enacted, providing for incorporation of a distinct class of institutions, in the general form of investment trusts, and subject to government regulation and examination, which institutions shall perform the functions of existing banks with respect to savings deposits;
Again, I’m out of my depth here but I’ve been doing some reading in order to get the basic idea of what they are advocating. First of all you have to understand that banks operate under what is called a
fractional reserve system. When you deposit $100 the bank keeps 10% or $10 in their vaults and then loans the other $90 out to someone else. At any given time the bank only has on hand a fraction, 10%, of the money people deposit. Hence bank runs before deposit insurance. If a run occurred on a bank and you got there after the 10% ran out you were out of luck. What this means is that banks essentially create money and they do so at an interest or profit to themselves. You deposit $100. They say yes we have your $100 any time you want it and in the meantime they create $90 by loaning out your $90 to someone else. That person spends the money and the receiver of that spending deposits it in their bank which keeps $9 and loans out $81. At this point $171 has been created fictitiously by these bank loans. This process continues on and on and the money supply expands exponentially. This is what underlies our credit system. You can easily see how when a bank gets into trouble through bad loans, risk or fraud that it can be the one card in this house of cards that brings the whole thing down.
So what they are advocating is a system requiring banks to retain 100% of your money in their vaults when you deposit it. This has obvious benefits. The solvency of banks is much more closely guaranteed this way. Deposit Insurance is made moot. Bank collapses need not be feared. U.S. taxpayer bail-outs of collapsed banks need never happen again. Citizens need not fear losing their savings should their bank close. Their money is in the vault.
But it also means that all that deposited money sits idly in the bank vaults and is not translated into loan-able money available to business or individuals. It also means banks need to make their profits via fees since they can no longer make their profits via interest on loans. Great risk is removed from the system but at the same time the money supply is shrunken dramatically. You will find various references to this idea called “100% money” or “narrow banking” on the internet. In some cases you will see it combined with a return to the gold standard but that is not a requisite component.
So what about credit and loans? They advocate the creation of an “investment bank” where people deposit money (not checking or other demand deposits) specifically for the purposes of investment. These funds are then used for making loans. Risk is taken. Interest is charged. Risk is therefore separated out into these new investment banks with depositors understanding, as with any other investment, that their investment is subject to that risk. Investment loans are also therefore made with money specifically set aside for that purpose and not people’s paychecks and ordinary expense paying money as happens today.
Skipping backwards just a little…
(3) That the Federal Reserve Act be further amended, to permit issue of Federal Reserve Notes in any amounts which may be necessary to meet demands for payment by Member-Bank depositors;
(4) That Federal Reserve Notes be declared full legal tender for all debts;
According to their plan the government is now on the hook for the banks debts, good, bad or indifferent, and is guaranteeing them. So the taxpayer is still on the hook, right? Skip forward again…
(9) That losses incurred by the Reserve Banks in liquidating particular Member Banks be collected, so far as legally possible, from stockholders of those banks.
Unlike our recent TARP bail-out of the failed and/or fraudulent bankers the writers of the Chicago Plan saw fit to put responsibility where it belonged. This would still likely result in the government and therefore the taxpayer being on the hook for much of the loses but it would a) require the responsible parties to the failure/fraud to pay up first and b) leave the government/taxpayers owning the remaining assets rather than leaving the fraudulent/failed bankers in ownership control and without having suffered the consequences of their failures.
A summation of this part of the proposal:
The primary objective of these proposals for permanent reform is that of effecting a complete separation, between different classes of corporations, of the Deposit and the Lending functions of existing commercial banks. The now typical commercial bank would, in effect, be broken up into at least two distinct corporations, say, a Deposit-Bank and a Lending Company. The Deposit-Bank would serve exclusively as a depositary and agency for transfer of funds (checking); it would be prohibited from lending or investing depositors' funds; it would derive earnings solely from service-charges. The Lending Company, on the other hand, would engage in the business of short-term lending, discounting, and acceptance; it would be prohibited from accepting demand-deposits, and even from providing their short-term creditors, if any, with any effective substitute for checking facilities; thus, it, like other corporations, would be in position to lend and invest only the funds invested by its stockholders (and, perhaps, bondholders).
Secretary Wallace presented the plan to President Roosevelt at a cabinet meeting on Tuesday, March 21 and followed it up with a memo on March 23. In November a revised version of the plan was again put forth by the Chicago economists. Both memorandum were essentially written by
Henry C. Simons with input and review of the others. Senator Bronson Cutting introduced the plan to the Senate as S. 3744, June 6, 1934 and Rep. Wright Patman did so in the House as HR9855. Everything I have read indicates that the proposal was not skillfully handled from a political angle, met great resistance from banking interests and their backers in Congress (Carter Glass in particular) and died with Bronson Cutting in his plane crash May 6, 1935.
The plan was brought forward again in 1939 as A program for Monetary Reform. Unfortunately my grandfather was bedridden with TB from March 1938 to March 1939 and sent most of the rest of 1939 regaining his strength so I have no indication whether he would have participated in this later plan or not though I suspect that he would have along with his good friend (and later Senator) Paul H. Douglas. Various people brought it up again in the later 40’s but it never came as close to being seriously debated as policy as it did in the wake of the great banking collapse of the early 1930’s.
Finding modern support for the idea to reside primarily with libertarians makes me a little leery of the idea. However, libertarians are not always wrong in their views. They just have a tendency to be way too extreme in them. And while some of the original promoters of the idea were the predecessors of today’s conservatives others such as Paul Douglas most definitely were not. Again, I don’t feel I have enough of an economic background to understand the broader implications of such a drastic change in the structure of our financial system. It seems to me that the idea of separating banking functions in this way has great merit. Similarly, putting control of the money supply back in the hands of the government and out of the hands of bankers has merit. It seems to me that the result would have to be a contraction of credit and that concerns me. At the same time it strikes me that this plan would result in a more secure system of credit availability and a restriction of the speculative nature of financial institutions gambling with our money rather than their own. Such a system would leave them liable for their own excesses and not endanger the economy as a whole. In other words a true “free market” mechanism in which the market place rewards or punishes appropriately based on the ability of the investor, speculator and entrepreneur.
As today is March 16, 2011 and we’ve recently experienced the greatest financial crash since that of 1929-1933 which produced this memorandum of March 16, 1933, I thought I would bring forth a little history for discussion and consideration today. What happened then were the Banking Act of 1933 and 1935. What happened in our time was the TARP bail-out and our continuing economic problems.