Financial Crises: Understanding the Postwar U.S. Experience

By Martin H. Wolfson | Go to book overview
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6
1974: Franklin National

The threat of a financial crisis developed again in 1974. The crisis was precipitated mainly by the effective failure of Franklin National Bank, at the time the twentieth largest bank in the United States.

This time the crisis had international ramifications. Franklin had large Eurodollar liabilities, and its difficulties were followed by the failure of a German bank, Bankhaus I.D. Herstatt; both banks had financed unsuccessful foreign‐ exchange speculation by heavy borrowing in the Eurodollar interbank market. The Federal Reserve acted as a lender of last resort to prevent instability in foreign as well as domestic financial markets. Such activity to protect markets overseas was a significant expansion in the use of lender-of-last-resort activities.

Before discussing the crisis itself, however, it is necessary again to follow the developments in the economy, and especially in the corporate and banking sectors, that created the conditions in which the crisis developed.

The 1970 recession ended in November, but the growth of the economy in 1971 was disappointing. Real GNP recovered strongly in the first quarter of the year from its low point in 1970, but growth in real GNP for the rest of the year averaged only 2.9 percent. Such low growth is atypical for the first year of recovery from a recession.

In addition, the capacity utilization rate increased only slightly from its low point of 75.9 percent in November 1970, and the unemployment rate averaged close to 6 percent for most of the year. Despite this evident slack in the economy, prices continued to increase at a 5.8 percent rate during the first half of the year.

These domestic developments, however bad, were nonetheless overshadowed in 1971 by the continuing balance of payments deficits of the United States and the difficulties of the dollar. The dollar came under increasing attack from speculators in 1971, and foreign central banks were forced to take in increasing amounts of dollars to maintain the system of fixed exchange rates.

The pressure became too much in late summer; President Nixon announced a New Economic Policy (NEP) on August 15th to try to address the domestic and international difficulties. The NEP suspended convertibility of the dollar into

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