BANKING CRISIS #2 The Panic of 1893 The economic crisis of the early 1890s in the United States had many deeply rooted causes. One of the many precursors was the depression in Europe that began in 1889. This caused demand for American goods to fall, while simultaneously forcing Europeans to cash in their investments in America. Railroads in the United States, which had been a main force for economic expansion over the last several decades, began to falter. Early in 1893, the Philadelphia and Reading Railroad declared bankruptcy, soon followed by many more railroad companies. Because a great deal of money had been invested in railroads, individual investors lost their money when a railroad went bankrupt, and other investors began to realize railroads were no longer a safe investment. As a result, investors began taking money away from the railroad sector of the economy. Banks, which had financed many of these railroads, lost money, and depositors began to worry about whether or not their bank still had enough liquid assets to satisfy their deposits. At the same time, the agricultural sector of the economy was also finding itself in a credit crunch. The wheat and corn farmers of the Midwest, along with the cotton farmers in the South, had experienced declining prices for several years. This not only meant they had less money to purchase new goods and services from other sectors of the economy, but they were also unable to pay their mortgages. Needing the liquidity from mortgage payments from farmers to compensate for the railroad catastrophe, banks found it difficult to stay solvent (stay in business). During the 1890s farmers banded together to advocate for favorable legislation in order to soften their financial burden. The details, motives and consequences, are complex, but farmers tended to favor the Free Silver movement. As a result, silver flooded the market, depressing its value. The United States economy still functioned on a representative money system. This meant paper money was redeemable in silver or gold. With the onset of the economic crisis and with silver's value consistently falling, people began redeeming money for gold. When the United States' gold reserve fell below $100 million--a psychological minimum threshold--the financial system panicked further. Due to these many factors, depositors, especially other banks, began to realize their money might not be safe in a bank. Bank runs began occurring in June and the system began to recover by July. Unfortunately, several banks suspended cash payments and refused to process large withdrawals. This made depositors very uncomfortable, causing bank runs to continue through September. The parts of the country hardest hit were not in the traditional financial center of New York City, though it did experience its share of bank runs. Most bank failures and economic hardships were experienced in the Mountain West where the silver mines were located, and also in the Midwest and Southern states where the main agricultural heart of the economy existed. QUESTIONS 5) Why did bank runs occur in 1893? 6) How were these bank runs an example of a self-fulfilling prophecy? In other words, how did depositors' negative perceptions of their bank cause them to behave in a way that actually made the bank fail? 7) How were these bank runs contagious? 8) The Federal Reserve was not created until 1913, which means there was very little bank regulation in 1893. If deposit insurance had existed, how might this have helped avert this banking crisis? 9) Even though the Federal Reserve did not exist in 1893, banks still had reserve requirements. Why was this regulation not enough to avert a crisis