CS Question #1: Why did President Roosevelt close the banks with his government-imposed "bank holiday"?

Three months later, President Roosevelt signed the Banking Act of 1933. This action created the Federal Deposit Insurance Corporation. The FDIC was designed to protect the funds of depositors. When a bank closes, withdrawing money from it becomes impossible. Funds previously deposited in the bank are lost. Investors and savers can lose any or all of the money they have placed in that bank. The FDIC created an insurance policy to replace the lost money. The FDIC's insurance fund is derived from bank assessments and interest earned in U.S. Treasury obligations, not from taxpayer money. This provides additional insurance to investors and savers. If the bank should fail or close, the government would be able to compensate individuals and businesses that risked losing their money.

Deposit insurance was an immediate success. Within a few years, stability had been restored to the U.S. banking system. In 1934, the number of failed banks dropped from thousands of institutions to only nine. During the next 30 years, the FDIC's banking regulators worked to secure the banking system. The FDIC's regulations and the banking institutions' precautions created few risks in the financial system. The confidence inspired by the banking system made the public feel that their money was safe. Once security was reestablished, individuals and businesses began using the banking system to save, invest and borrow money.

CS Question #3: How did the FDIC inspire confidence in the U.S. banking system?

In the past decade, the size and number of bank failures has greatly increased. This is partly due to the growing levels of competition within the banking industry. Banks have become more responsive to the credit needs of their customers and more willing to take on greater risks to meet these credit needs. This growing competitive environment is very positive for consumers in the United States. Remember that in a free market, competition helps to decrease costs for consumers. In today's economic environment, banks are more vulnerable to changes in economic conditions.

The Savings and Loan Crisis of the early 1980s is a good example. Savings and loans were different from commercial banks because they primarily received money from individuals who opened savings accounts and lent money to individuals who purchased homes. These loans, called mortgages, were locked in at a specific interest rate for a long-term period, usually 15 to 30 years. In the early 1980s, interest rates began to rise. This presented a problem for the savings and loans. They needed to pay higher rates of interest to savers, but they were locked in at lower rates of interest from the people who were paying their mortgages. In other words, they were paying out more money than they were receiving. The savings and loans asked the government for the freedom to be able to make other investments and compete with commercial banks. They wanted to invest money in other areas to make a higher rate of interest. The government allowed for the deregulation of savings and loans. This allowed the individuals who managed the banks to make investment decisions. Over the next several years, officers at these savings and loan facilities loaned money to many groups, individuals and corporations that were unable to repay their debts. They also made poor investments in unsuccessful projects and committed acts of fraud. As customers defaulted on loans, many savings and loan facilities went bankrupt. The FSLIC, or Federal Savings and Loan Insurance Corporation, was unable to save these banks. Eventually, the FSLIC became insolvent. In the end, the FDIC had to step in and bail out the savings and loans. It is estimated that the cost to fix this problem ranged from $325 to $500 billion over 30 years.

CS Question #4: Why did the savings and loan facilities fail in the early 1980s?

Further Thought:

1. What are the social and economic costs of a bank failure?
2. Who is most responsible for keeping the U.S. banking system safe and efficient?
3. How can the government insure deposits and still create incentives for banks and individuals to invest their money wisely?