The Boom and Bust Phenomenon and U. S. Bank Failure Experience, 1914-1934

Abstract:     
This paper is a theoretical and empirical investigation of the causes for the widespread bank failures of the 1920s. The purpose is to formalize and compare some of the extant arguments for failure, and to re-examine the particular historical period 1914-34 with the benefit of new evidence. A model is developed that is sufficiently general to capture the effects of extreme competition, heterogeneity among bankers, and macroeconomic surprises on bank solvency. Both entry into the banking industry and macroeconomic surprises have the potential to increase the failure rate. The model motivates an empirical study of annual statewide aggregate data on bank balance sheets, income statements, and failure rates. The empirics suggest that the high rates of bank failure observed in the 1920s are part of a boom- and-bust phenomenon. Specifically, we find that high statewide failure rates were preceded by large growth rates in the number of banks.

JEL Classifications: D40, E44, G21, G28

Working Paper Series