Suspension of payments, bank failures, and the nonbank public's losses

Abstract

Suspensions of payments are an important part of many explanations of the rise of the Federal Reserve, theories of banking panics and even counter-factual evaluations of the Great Depression. To date though, there is no evidence on suspensions' effects. We present evidence about suspensions of payments from an episode that is close to a controlled experiment for examining their effects. In 1861, about 44 percent of the banks in Wisconsin closed, 87 percent of the banks in Illinois closed, and noteholders suffered substantial losses. The historical record suggests that an effective suspension of payments in Wisconsin but not in Illinois may be the explanation. Historical and statistical evidence indicate that the suspension of payments decreased the number of banks that closed as well as noteholders' losses. Our statistical evidence indicates a 20 percent increase in the probability that an average bank in the two states remains open with the suspension of payments. The suspension of payments decreases noteholders' losses by about 15 cents per dollar of notes.

Why do banks promise to pay par on demand?

“…This is consistent with empirical evidence, which indicates that banking panics are explicable responses to bad states of the world (Rolnick and Weber 1984;Gorton 1988;Economopoulos 1990;Dwyer and Hasan 2006. ) A number of papers have focused on the incentive properties of demand deposits.…”

“…These bonds held as backing for the notes were marketable securities traded on the New 48 See (Dwyer 1996;Dwyer and Hafer 2004;Dwyer and Hasan 2006. )York Stock Exchange and are not really a plausible basis for an asymmetric-information explanation of banking.…”

“…But a money market's 50 See (Dwyer, Hafer and Weber 1999;Hasan and Dwyer 1994;Dwyer and Hasan 2006. ) 26 per share NAV may fall below $1.00 if the investments perform poorly.…”

The Effects of Government Interventions in the Financial Sector on Banking Competition and the Evolution of Zombie Banks

“…Aghion, Bolton, and Fries (1999) discuss closure rules and banks' incentives, and Gorton and Huang (2004) propose that government interventions improve welfare when private parties cannot provide liquidity. This view of a 'bright side' of interventions is also supported by Dwyer and Hasan (2007) who show that suspending convertibility reduces the number of bank failures. In contrast, Diamond and Rajan (2005) illustrate a 'dark side' of bailouts because they may trigger increased demand for liquidity and additional bank insolvencies.…”

American Banking and the Transportation Revolution Before the Civil War

“…However, while these few changes affect the timing of the second or third bank in a county, they do not change the date at which a county gained its first bank. the prices of southern bonds that could be used to back their note circulations (Dwyer andHasan, 2007, Economopoulos, 1988). …”