in the 1920s, the banking system helped spread prosperity. in the 1930s, it dragged america down. how could a holiday put an end to the deepening crisis? banking deregulation cost taxpayers almost a half trillion dollars. did banks need more regulation or less? our nation has long tried to protect the banking business, but we've never eliminated all the risks. the banking system: why must it be protected? economic analyst richard gill and i will investigate that question on economics usa. i'm david schoumacher. captioning made possible by the annenbercpb project will investigate that question on economics usa. america's businessmen and women know how dependent they are on a friendly bank for their success and the growth of their communities. america's banking system has provided that success and growth for more than a century. although most banks are healthy and long-lived, historically we have faced bank failures. while we can accept other businesses failing with a shrug, a bank closing is another matter, as we learn in our story. new york early in the century, financial capital of america. it was money that kept new york moving and growing, money that built its elevated trains and skyscrapers. most of the money that built new york came from the banks, from the powerful national firms on wall street to the more modest, like the knickerbocker trust, which served the city's neighborhoods. working-class families kept their savings in the knickerbocker. storekeepers dropped off daily receipts there and borrowed there to buy merchandise. wealthy matrons used their checking accounts to shop fifth avenue. captains of industry invested their corporate profits at the knickerbocker trust. as banks have done for centuries, the knickerbocker reserved a fraction of deposits and loaned out the rest. wall street analyst henry kaufman explains how a bank earns money. banks tended to earn money the same way as they do today, in a general way, by making loans and investments. there was, in those days, in hindsight, a somewhat greater risk-taking than has tended to occur within the last 40 years or so in the united states or in banking in modern times. it was and had a stronger entrepreneurial drive in those days. and at the same time, there was inadequate governmental supervision. charles barney, the knickerbocker's president, was one of those entrepreneurs ambitious for his bank's success. apparently, for charles barney, the chance came to make a lot of mon, if he was willing to risk the bank's money. barney knew a speculator named charles morse. morse and a partner, frederick hines, schemed to manipulate copper's price on wall street. copper was a hot item many peoplspeculated on. schthere is debate,te copper'shistoricly,all street. over the extent of bary's involvement, but many believe he made the behind-the-scenes arrangements as the morse-hines combine began setting its trap in early 1907. historian robert sobel explains. hines came to new york, where he met morse, a small-time speculator. their plan was to get several banks behind them and use the banks' assets to create a new copper company, united copper, push the stock up, and squeeze those people who sold the stock thinking it would go down. what happened? the stock market was heading downward because of a money crunch. the economy was overheating. many people were frightened of a crash. they took their gold out of the banks. people knew the knickerbocker was connected with united copper, which started to collapse. depositors started to appear and said, "give us our gold," and the money started flowing out. had the knickerbocker been just a major bank, they would have told morgan, "help us, or there'll be a panic." on sunday, october 20th, charles barney left his home here on park avenue to appeal to the only source that he knew could save him--j.p. morgan. morgan had helped banks in trouble before. he wasne of the w men with the resources and reputationo do it. but when barney got to morgan's headquarters here at his library... morgan wouldn't even see him. for barney, disaster was now inescapable. rumors took on a life of their own. monday, the runs on the knickerbocker began. panicked depositors withdrew their savings. tuesday at noon, the knickerbocker's cash was gone. the panic spread to other banks until 246 banks across the country closed, their customers out of luck. j.p. morgan, realizing the entire system was threatened, not to mention his holdings, finally stepped in to endhe panic of 1907. under his leadership, a large reserve nd was put together. then, facing appeals from banks, trust companies, and brokerage rms, morgan met with a group of bankers in his library. together they often worked through the night. it's said that at one point, morgan locked them in while they argued over which firms to save. morgan played solitaire at his desk until they made their decision. morgan had saved the day, as a grateful nation acknowledged, but the panic's costs were high. it affected banks, businesses, and personal lives, including that of a disgraced, distraught charles barney, who killed himself. ironically, the knickerbocker trust was not a bad bank. it reopened five months later. the people who frantically lined up here got most of their money back. the nation's bankers faced two important realities. could they allow the power to save the banking system to remain in the hands of a j.p. morgan? the bankers turned to the federal government. they accepted the need for a central bank. the other important reality was that despite all its inherent instability, the bankers wouldn't give up fractional-reserve banking. economic analyst richard gill explains why. why bankers wouldn't want to give up a fractional-reserve system is pretty obvious. they make money by lending. is this somehow sinful? hardly. if they didn't make money on loans, they'd charge us hefty fees on deposits. most of us would regard this as even more sinful. the knickerbocker case was a bit alarming, but most of the time, fractional-reserve banking works well. here's how a commercial bank's balance sheet might look. we have two columns here, assets and liabilities. assets are what the bank owns. liabilities are what it owes. in this stripped-down case, the bank's assets consist of money we have deposited and its loans to businesses. this banks owns a claim of $80 million against industrial firms who have borrowed money and will pay interest to the bank. against these assets, we have what the bank owes to its depositors, what we call demand deposits, since they are payable whenever we write a check on them. what fractional-reserve banking means isn't that assets exceed liabilities-- you see they balance at $100 million-- but that the bank's demand deposit liabiliti exceed the bank's cash reserves. the fraction here is 1/5. the knickerbocker case shows that there is an inherent vulnerability in this kind of banking. if this bank's loans turn bad, it can get into trouble. even if they are o.k., the bank can face trouble if people believe it's in trouble. if everybody wants their cash back, obviously our bank can't satisfy them. believing makes it so. but this same principle also explains why the system usually works just fine. believing our money is safe makes it so. most of us never think about our bank's balance sheet. we have no need to, usually. 25 years after the panic of 1907, the country was torn and nearly overturned by the great depression. banks failed by the thousands, and many felt the banking system contributed to its collapse. how could this happen? could anything prevent it from getting worse? the federal reserve, washington, d.c. the central bank was a kind of institutionalized j.p. morgan. it was intended as a lender of last resort, loaning money to banks which were basically sound, but temporarily in need of shoring up. all nationally chartered banks were automatically members of the federal reserve system, and many state banks joined as well. did the federal reserve work? through the 1920s, there were few complaints. in fact, the presence of the federal reserve reflected and reinforced the times' optimistic view. the banking system supported the twenties' boom. it increased the amount of money circulating. how did the banking system create money? through loans. as a loan was granted, credit was created. more money flowed through the banks. it had a multiplying effect. workers put their wage into a bank where it was loaned out to people buying cars. auto company profits could be invested in steel mills, and so it would go, more and more money flowing through the banks. would we grow forever? henry kaufman explains why most americans in the twenties thought so. when you get into an economic expansion, the commercial banking system, or a financial institutional structure, can aggravate problems by becoming too liberal in its loans, allowing a liberalization in credit standards. now that immediately drives the economy very sharply, but with time, adds to problems. banks gave investors liberal loans. investors in turn speculated wildly on the stock market. wall street boomed until black thursday. october 24, 1929, the inevitable happened. the market fell. the crash pushed the country into the great depression. americans suffered from an economy grinding down, money in circulation drying up. workers lost their jobs and withdrew their savings. loans weren't made to industry. many losses couldn't be recovered. people weren't buying new homes or cars. they were lucky to keep what they had. the economy hurt the banks, and the banks hurt the economy. historian eugene white explains. banks' problems began to feed the fires of the depression through a multiple credit contraction. once a bank ceased to make a lot of loans, when it began increasing its reserves, not making new loans to new customers, an increasing number of businesses began to fail. businesses couldn't pay back their loans. many banks found their loans weaker, and they contracted even further. so it was a slow unwinding of the financial system. what was the federal reserve doing? the fed was supposed to engage in a countercyclical policy to counteract trends in the economy. but instead, it, at the beginning, began to play a very neutral role. it just let the banking system slide very slowly into chaos. once again, panic took hold. in 1930, 1,000 banks failed. in 1931, more than 2,000. in 1932, the american people looked to new leadership to lift the country out of its economic crisis. i propose to show that this leadership misunderstood the forces that were involved in the economic life of the country. it encouraged speculation and overproduction through its false economic policy. incumbent president herbert hoover was routed at the polls by franklin delano roosevelt. this great nation will endure as it has endured. first of all, let me assert my firm belief that the only thing we have to fear is fear itself. in his inaugural address, roosevelt pledged to establish strong banking safeguards. there must be a strict supervision of all banking and credit and investments. there must be an end to speculation with other people's money. one of roosevelt's first presidential acts was to declare a national bank holiday. merritt sherman, who was with the federal reserve then, tells us why roosevelt took this action. what roosevelt was trying to do was to create a period in which the whole banking system, individual banks, could be reviewed by bank examiners, by experts who had a great deal of information about banks, and enable them, through the procedure of licensing banks to reopen, to carry out the promise made by the president that any bank that was reopened would be able to stay open. in his fireside chat, fdr told the nation that the reopened banks were safe. let me make it clear that the banks will take care of all needs. and it is my belief thatoarding, during the past ek, s become an exceedingly unfashionable pastime. roosevelt did more. legislation following the bank holiday extended the federal reserve's powers, forced banks to meet tougher regulatory standards, p and created the federal deposit insurance corporation to guarantee customers' accounts up to $10,000. give me my 60 cents. how do i know you got 60 cents? here's my bankbook. all right, that's fine. 5, 10, 15, 20, 25, 30, 35, 40, 45, 50, 55, 60. that's o.k. americans showed their faith in the reopened banks and the crisis passed. the bank holiday was a watershed. it's remembered as one of fdr's most popular political moves. but, richard gill, was it really necessary? what had happened to the money supply? well, the money supply shrank drastically between 1929 and 1933. by money supply, we mean not just coins and currency, but also our checking accounts in the banks. since we make most major purchases by checks, rather than cash, these deposits are the most important part of our money supply. commercial banks can actually create these deposits, actually create money. this seems a bit much, but it's a simple consequence of our old friend, fractional-reserve banking. let's follow a million-dollar deposit in the banking system. let's suppose a rich widow, frightened by the panic of 1907, has been keeping her million in cash under her mattress. now, in the twenties, she deposits it in the bank. the bank has $1 million more in cash, and she has a million-dollar demand deposit. here's the fractional part. the bank lends out $800,000 to businessmen. the businessmen withdraw this money. our bank now looks like this. the businessmen take this money and pay it out to workers, landowners, and so on, who deposit it in their bank. now a second bank has a new deposit. but now the second bank, on the familiar fractional-reserve principle, lends out $640,000 of its new cash. its balance sheet now looks like this. but look what's happened. there are now $800,000 more demand deposits in the economy, $800,000 more money in the economy. we have the original $1 million in the first bank, plus $800,000 in the second bank. you ain't seen nothing yet. this $640,000 the second bank lends becomes a deposit in a third bank, and so on. we have had, by the time we are finished, a multiple expansion of money throughout the economy. the same process can also work in reverse, as it did during the great depression. no wonder roosevelt called for a bank holiday. no wonder our money supply collapsed so completely. for almost 50 years after the depression, the banking system worked-- and worked well. federal laws guaranteed deposits and kept banks and s&ls out of high-risk ventures. in the seventies and eighties, the government gave s&ls the green light to offer higher interest and get into high-payoff real estate deals. high-rolling s&l executives gambled on real estate and lavished depositors' money on imported marble and crystal. they lost...big, and the taxpayers got the bill-- almost a half trillion dollars. commercial banks had troubles, too, losing money on loans to third-world countries and high-risk junk bond offerings. they looked to washington for help. how could the government keep what happened to s&ls from happening to banks? did banks need more restriction to make sure they weren't risking taxpayer-guaranteed deposits? or should banks be able to expand across state lines or into the securities or insurance businesses so that they could earn higher profits and not take risks with depositors' money? the debate reopened issues first argued in the thirties-- issues passed down, literally, from father to son. president george bush sent congress a bill that would allow banks to provide a variety of financial services, echoing the potion his father, senator prescott bush, had taken 40 years before. congressman john dingell jr., chairman of the house energy and commerce committee, asked whether giving banks more freedom wasn't asking for economic trouble, the same concern his father, congressman john dingell sr., had voiced over 50 years before. my daddy taught me there's no educational value in the second kick of the mule. i've tried to learn from others' mistakes. the banks propose to rush out and get into many businesses. wouldn't the bush banking bill open the door for banks to speculate in new business with federally-insured deposits, just as s&ls did? we're not talking about taking insured deposits from banks and going into the securities business or the insurance business. what you do is you build these walls that say no insured deposits can hop over from the bank to fund any kind of risk-taking, any activities in these other areas. wouldn't banks know best about how the banking industry should be reformed? they've had huge successes in bringing themselves to their knees. they want to tell congress how banking should be restructured. they want to bring their expertise into insurance, real estate, securities, to cause a successful collapse in those areas. the basic economics is there's a business judgment. not all business judgments are correct. the market will penalize those that are wrong. the market will evaluate these institutions. they're the best judge, not the government, as to what should be offered to consumers. the battle over banking laws wound up on the floor of the house of representatives. and when the votes were counted, the president's bill lost, and the legislative walls that restricted banks to banking still stood. there may have been only one thing that george bush and john dingell, like prescott bush and john dingell sr., agreed on. however it was done, the banking system pumps the economy's life's blood and had to be protected. how do economists view banking regulation? we asked economic analyst richard gill. how do economists view banking regulation? with ambivalence. it can be and has been argued that it was deregulation that threw s&ls and and commercial bankservision into disarray. or it can be been argued that the real problem has been government intervention-- raising the level of deposit insurance to $100,000 and thus encouraging high-risk loans and investments. in the final analysis, the real issue isn't so much regulation versus deregulation as it is how to protect depositors without giving a green light to the reckless and imprudent. everybody agrees that a sound economy requires a reliable banking system and that it's the government's job to guarantee that reliability. that's why the government supported the banks after the panic of 1907 and why the bankinsaty net was reinforced in the great depression. it's why we've paid hundreds of billions of dollars to stand behind the government's guarantee of deposits in bankrupt s&ls. it's also why, although they disagree on political philosophy, the policymakers in the white house, congress, and at regulatory agencies don't argue whether to protect the system, but how. for economics usa, i'm david schoumacher. captioning performed by the national captioning institute, inc. captions copyright 1992 educational filmenter annenberg media ♪ for information about this and other annenberg media programs call 1-800-learner and visit us at www.learner.org. here, kitty, kitty! here, kitty, kitty, kitty! here, kitty, kty you'd think it would be easy to tell which kids had trouble with their eyesight. [ thud ] but that's not always the case. even though one in four children may have a vision problem, eye doctors tell us the symptoms aren't always so obvious. we do know that 80% of all childhood learning is visual. and without good vision, kids can have trouble learning to read. [ girls screaming ] ow! and may fall behind in school. for clues on how to spot the real-life signs of childhood vision problems and what parents can do, visit checkyearly.com. a public service message from the vision council of america and reading is fundamental.