WHAT A HOLIDAY! "... The nationwide banking holiday marked the turning point of the Great Depression. [The] recovery would not have been possible had the public not been convinced not only to quit withdrawing money from their banks, but to start putting it back into them.".

• Author: Selgin, George
• Position: USA YESTERDAY

DURING the opening days of March 1933, the U.S. economy resembled a stricken body slowly bleeding out, its organs failing one by one. The Federal Reserve System was hemorrhaging gold, and entire state banking systems were shutting down one after another. If the economy was to survive and recover, Pres. Franklin D. Roosevelt first had to staunch the bleeding and then arrange for a transfusion.

Before we consider how FDR managed to end the nationwide banking crisis that broke out on the eve of his inauguration, let us recall just how that crisis came about. It began with the official closing of Michigan's banks in mid February 1933. Michigan's decision led other states to start declaring holidays as well. In the meantime, fear of an impending devaluation led to foreign and domestic runs on the dollar. Together, these events set the stage for Roosevelt's declaration of a nationwide bank holiday on March 6, two days after taking office.

So much for the barest facts. In Drifting Toward Mayhem, his superb but underappreciated history of the Depression-era banking crises, historian Robert Lynn Fuller supplies many crucial details. Perhaps the most striking of these is that "hysteria" did not take hold of bank depositors until after state governments everywhere began shutting down or limiting withdrawals from banks. Until then, it mainly was commercial bankers and (most importantly) Federal Reserve officials who went into panic mode.

During the "wave of fear" that immediately followed Michigan's crisis, Fuller says, "the public remained mostly calm. . . . Depositors did not rush to their banks to withdraw cash." Instead, the wave got started by bankers and state politicians who mostly reacted not to actual depositor runs but to "each other's anxiety about what might happen."

The governors of Tennessee and Maryland followed Michigan's example by declaring their own bank holidays, while those of 17 other states allowed their banks to limit depositors' cash withdrawals. However, such responses only gave bankers elsewhere more reason to panic by denying them access to correspondent balances that often made up a substantial share of their liquid reserves or by making them fear they might lose access to those balances at any moment. The ensuing scramble for funds upped the pressure on governors who had not yet done so to relieve the pressure on their banks.

As holidays and restrictions multiplied, ordinary bank depositors were bound to join the fray, not because they went berserk, but because they also feared being frozen out of their own accounts. Thus, when crowds gathered to withdraw their savings from a bank, as they did in Newark, N J., on March 2, when they lined up in front of the Howard Savings Institution, they did so not because they feared it might be broke, but because they believed that New Jersey's governor was about to declare a holiday that would put their savings out of reach. Fear of local holidays thus joined the growing anxiety that FDR would suspend gold payments to inspire people to get their money out of banks that often not only were solvent but understood to be so by those who ran on them.

Once one allows for such (perfectly rational) fears of both state bank holidays and devaluation, there is not much need, after all, for any appeal to depositor hysteria. This does not mean that depositors never mistook sound banks for unsound ones during those months, and it certainly does not mean that there were no unsound banks left after those around Detroit went belly-up, but it does cast doubt on the view that depositors had come to generally suspect their banks of being broke.

It was the run on the dollar, and especially foreigners' part in it, that ultimately led the Federal government to shut down the entire U.S. banking system. Although that run harmed commercial banks, it was less of an immediate threat to most of them than to the Federal Reserve System itself, and the New York Fed in particular, for it was a run out of dollars of all kinds and into gold, where that gold was mostly kept at the New York Fed.

The final, fatal blow to the nation's banks came when the "wave of fear" engulfed New York Fed officials who, Fuller writes, "reacted against future expectations of actions by European central bankers, who acted on their own worries about the...