The Founding of the Federal Reserve, the Great Depression and the Evolution of the U.S. Interbank Network

Abstract

Financial network structure is an important determinant of systemic risk. This paper examines how the U.S. interbank network evolved over a long and important period that included two key events: the founding of the Federal Reserve and the Great Depression. Banks established connections to correspondents that joined the Federal Reserve in cities with Fed offices, initially reducing overall network concentration. The network became even more focused on Fed cities during the Depression, as survival rates were higher for banks with more existing connections to Fed cities, and as survivors established new connections to those cities over time. 1 Other theoretical studies of the channels through which networks can transmit shocks include Allen and Gale

Expect Success, Get Success

“…Self-fulfilling prophecy stems from purposeful behavior. The nearly 50 percent of US banks that failed during the Great Depression failed because people acted upon their expectation that banks might collapse (Wheelock 2013). They withdrew their money in droves large enough to cause the failure they expected, therefore completing the selffulfilling prophecy.…”

“…Self-fulfilling prophecies result in predicted outcomes in organizational contexts and also in societal contexts. A classic example of self-fulfilling prophecy is anxious depositors who withdrew their savings out of fear of bank closures, which produced the precise event they expected and contributed to the Great Depression (Wheelock 2013). As another example, after the Option Pricing Theory published by Fischer Black and Myron Scholes in 1973 became widely known, deviations from the price of the option reduced substantially.…”