Bank panics, as the name suggests, were crises in the banking industry in the 1800s and early 1900s usually created when the general public had serious questions about the solvency of banks and the safety of their deposits. Bank panics were often sparked by bank runs in which an usually large number of depositors sought to withdraw funds at the same time from their banks. The run on a single bank, and its subsequent failure, often created the uncertainty and distrust of the banking system that led to an economy-wide bank panic.
While all too common a century ago, bank panics have largely vanished from the modern economic landscape thanks to government deposit insurance (Federal Deposit Insurance Corporation). Because such insurance guarantees bank deposits, customers are less concerned about losing their deposits and thus likely to panic if problems emerge.
A Panic ContractionIn the 1800s and early 1900s business-cycle contractions were, more often that not, caused by economy-wide bank panics. For this reason economic downturns were more commonly termed bank panics than recessions or contractions.
Bank panics triggered economic downturns by reducing the amount of money in circulation. Before the advent of deposit insurance, the run on a bank was likely to deplete the bank's available reserves, causing it to fail and making any remaining deposits worthless. When such bank runs spread throughout the economy as bank panics, a significant amount of the economy's bank deposits literally vanished.
These lost deposits reduced the economy's stockpile of financial wealth and, more importantly, the supply of available money. With less money in circulation, less output was purchased, meaning production, employment, and income all declined. This was, and continues to be, one sure recipe for a business-cycle contraction.
Some Notable PanicsBank panics were a common occurrence in the U.S. economy throughout the 1800s and into the early 1900s. The first notable bank panic took place in 1819 after the war of 1812 in large part due to tight lending policies by the Second Bank of the United States. The last of note was in 1932, during the depths of the Great Depression, which then prompted the formation of the Federal Deposit Insurance Corporation. Other major panics that marked the U.S. economic landscape occurred in 1837, 1857, 1869, 1873, 1893, and 1907.
The bank panic of 1857 was the result of European speculation in the construction of the U.S. railroad system. When the speculation investment bubble burst, the panic began. The 1869 bank panic was triggered by the first of several stock market collapses known as "Black Friday." The panics in 1873, 1893, and 1907 were caused by ongoing financial conflicts between farmers and bankers that, among other things, also gave rise to the Populist political movement. The bank panic of 1907 was noteworthy for inducing Congress to create the Federal Reserve System, which was officially established 1913.
A Thing of the Past?Bank panics appear to be relegated to the history books. The Federal Reserve System, Federal Deposit Insurance Corporation, and a better understanding of how economy works, has effectively prevented bank panics since the Great Depression. A potential bank panic that could have occurred with a major decline in the stock market in 1987 was avoided. And even though hundreds of banks failed during the 1980s due to bad management and a bad economy, no economy-wide bank panics emerged.
So far, so good. But can bank panics happen again?
The key is keeping the banking public calm, keeping them assured that their financial wealth is not at risk even if banks fail. The banking public did remain relatively calm in the 1980s because federal deposit insurance worked. Insured deposits remained safe. The public had no reason to panic.
However, the federal deposit insurance system was stretched and strained during this decade. The Federal Savings and Loan Insurance Corporation, which insured the deposits of savings and loan associations, was stretched to the point of breaking and had to be merged with the healthier Federal Deposit Insurance Corporation. Had more banks failed, then the Federal Deposit Insurance Corporation might have been stretched to its limits as well. The only recourse would then have been direct support from the federal government, that is, using general tax revenues.
Unfortunately, total bank deposits far exceed government tax collections. Should the economy and banking industry once again experience problems similar to the 1930s Great Depression, the federal deposit insurance system might be strained to the breaking point. The federal government could lend some tax support, but not a lot. It too could be quickly strained to the limit.
If so, then the banking public might begin losing deposits, financial wealth, and confidence. This is just the sort of thing that can trigger bank panics.
BANK PANIC, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2020. [Accessed: January 17, 2020].