What caused Chicago bank failures in the Great Depression? A look at the 1920s

Abstract

This paper reassesses the causes of Chicago bank failures during the Great Depression by tracking the evolution of their balance sheets in the 1920s. I find that all Chicago banks suffered tremendous deposit withdrawals; however banks that failed earlier in the 1930s had invested more in mortgages in the 1920s. The main problem with mortgages was their lack of liquidity, not their quality. Banks heavily engaged in mortgages did not have enough liquid assets to face the withdrawals and failed. This paper thus reasserts the importance of pre-crisis liquidity risk management in preventing bank failures. While not excluding an important role for lenders of last resort as a within-crisis solution, emphasis on banks’ long-term investments in illiquid assets implies a role for regulatory authorities in crisis prevention.