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Sitting ducks: banks, mortgage lending, and the Great Depression in the Chicago area, 1923-1933

Postel-Vinay, Natacha (2014) Sitting ducks: banks, mortgage lending, and the Great Depression in the Chicago area, 1923-1933. PhD thesis, London School of Economics and Political Science.

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What are the main causes of bank failure? This thesis contributes to answering this question by focusing on the city of Chicago during the Great Depression, which experienced one of the country’s highest urban bank failure rates. Focusing on the long-term evolution of state banks’ balance sheets, it finds that what greatly mattered for their survival was the inherent liquidity of their pre-Depression portfolios. Indeed, all banks, including survivors, suffered tremendous deposit withdrawals. Yet those that ended up failing could be identified as weak ex ante. Such weaknesses were linked to the inherent liquidity of their portfolios: the higher their amount of long-term illiquid assets (in particular, mortgages) before the Depression started, the more likely they were to fail ex post. The first paper identifies mortgage holdings as the most important predictor of bank failure, and explains how their intrinsic lack of liquidity came to matter more than their low quality. The second paper zooms in on mortgage contracts themselves, and finds that debt dilution due to the “second mortgage system” led to a lower probability of repayment. Nevertheless, this second paper shows that increased default rates affected banks only insofar as foreclosure was a long drawn-out process that lasted more than eighteen months in Illinois – a great impediment to bank survival in case of a liquidity crisis. The third paper asks whether mortgage securitization would have solved the liquidity issue, and uncovers the extent of actual securitization taking place at the time in Chicago. However unbinding commitments and the lack of a regulated exchange created inefficiencies not unlike those of today. Together these results reassert banks’ responsibility in liquidity risk management. While credit risk continues to be an essential feature of banking, and has been recognized as such, renewed attention needs to be paid to the ways in which banks manage the inherent liquidity of their portfolios.

Item Type: Thesis (PhD)
Additional Information: © 2014 Natacha Postel-Vinay
Library of Congress subject classification: H Social Sciences > HC Economic History and Conditions
Sets: Departments > Economic History
Supervisor: Ritschl, Albrecht and Accominotti, Olivier

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