Using unique records from the Freedman’s Savings Bank, we examine how heterogeneous depositor groups react to a bank’s expansion and emerging financial distress. We find that White depositors begin providing significant funding as interest terms are enhanced, but respond more quickly to changes in the bank’s perceived stability than the Black depositors who were the bank’s primary philanthropic target. White depositors are then twice as likely to close their accounts prior to failure, mitigating their uninsured deposit risk. Our results show how the demand deposit structure of simple financial institutions can create systemic disadvantages for minority communities.
The research project to collect and organize the data on the Freedman’s Savings and Trust was created to facilitate the research paper listed here. The detailed appendix to this paper also documents our data collection efforts. Please cite this paper if you use the information provided in this collection.
Traweek, Virginia and Wardlaw, Malcolm, Societal Inequality and Financial Market Participation: Evidence from the Freedman’s Savings Bank (2023). Available at SSRN: https://ssrn.com/abstract=3164418 or http://dx.doi.org/10.2139/ssrn.3164418
The Freedman’s Bank was founded in 1865, following the United States Civil War. Chartered as a private bank with a partially philanthropic mission, the goal of the Freedman’s Bank was to encourage thrift and savings activity among the population of newly freed slaves. The bank offered only depository accounts and was seen as a thrift bank, which was generally regarded as the safest type of bank. While the bank eventually became involved in commercial lending activity, this lending almost exclusively involved real estate investments to white investors in the Washington D.C. area and did not extend its commercial lending services to its primary depositor base.
Initially, the Freedman’s Bank focused on soldiers who had just received their military pensions, but the focus soon shifted to local banking. The branches stretched from New York City in the northeast to Tallahassee, New Orleans, and Shreveport. At its height in 1873, the bank had over 70,000 accounts and more than 30 branches, eventually operating in most major cities in the southern United States, eventually attracting a small number of white depositors as well, attracted by the significant real return on deposits. The bank represents one of the single largest attempts to uplift disenfranchised minorities through financial participation. As proclaimed by noted abolitionist Frederick Douglass:
“This institution conspicuously and pre-eminently represents the idea of progress, and elevation of a people who are just now emerging from the ignorance, degradation, and destitution entailed upon them by more than two centuries of slavery.”
The Freedman’s Bank began to falter in late September 1873, following the rapid failure of Jay Cooke & Company. Jay Cooke & Company was a major investment bank in the United States based in New York City. Heavily invested in railway debt, which was rapidly declining in value, Jay Cooke & Company found itself unable to liquidate and unwind an enormous bond position, triggering a run by investors, which resulted in an unexpected declaration of bankruptcy almost overnight. The failure triggered a nationwide financial panic, eventually termed the Panic of 1873, which set off a number of bank runs across the country, including at the Freedman’s Bank. Although the runs subsided and the Freedman’s Bank remained open until the summer of 1874, the bank was permanently weakened by the crisis. The crisis significantly damaged the balance sheet of the bank and put substantial pressure on a large pool of questionable real estate loans that the bank held. After an attempted reorganization by a federally appointed commission, the bank officially failed 9 months later in July 1874.
Using unique account-level records, the study reveals that new White depositors, whose deposits became increasingly crucial for the bank’s total funding, demonstrated a proactive response to both stability and instability. They increased their deposits significantly in advance of an apparent stabilization of the bank in early 1874 and were more likely to withdraw their funds before the bank’s failure in July 1874. This suggests that White depositors were more financially sophisticated and had better access to information, allowing them to mitigate their losses more effectively than non-White depositors.
The Freedman’s Bank was swept up in the initial panic and experienced both a massive drop in new deposits and a run on existing deposits. Depositor reaction did not manifest as a slow diffusion of information from New York, the location of the Jay Cooke & Company failure, to the rest of the country. Instead, the decline occurred just as quickly, and actually more sharply, in branches outside of New York City, and deposit activity remains permanently depressed in branches further from the source of the panic. The decline in deposits was also more pronounced for counties in which the African American population growth was higher and for branches whose depositor base had fewer local depositors who were born and raised in the state. This suggests that large influxes of new people into urban areas have a distinct impact on societal trust as the depositor base becomes larger but potentially less cohesive. We also find a role for local organizations in hardening the banks’ deposit base. Along similar lines, institutional investors, such as churches, civic organizations, charitable institutions, and businesses appeared less likely than individuals to deplete their deposits. The presence of these depositors provided a level of stability to the bank that may have helped it weather the panic. However, this assistance in temporarily stabilizing the bank ultimately came at deep cost 9 months later when the bank failed.
As previously described, the bank was weakened by the initial panic in September of 1873, but it survived, and operations recovered in early 1874 as the bank continued to operate. However, the bank ultimately failed catastrophically, and the wealth in accounts not closed prior to the failure was lost. In a process taking nearly 10 years, the remaining assets were liquidated, and account holders who were able to verify their accounts were paid a sequence of small dividends representing 62 cents on the dollar.
We use the record of the final ledger of accounts, created during the resolution of the bank, to examine the characteristics of the depositors who closed their accounts prior to the final failure of the bank in July of 1874. As the bank expanded in the early 1870s, it saw a small but sustained growth in white depositors attracted by the significant real return on deposits. These white investors, who made up around 10% of depositors, were nearly twice as likely to close their account before the failure. Consequently, the bank’s losses were disproportionately sustained by the bank’s majority black depositor base. Within the black depositor base, businesses and civic organizations are also less likely to have successfully closed their account, as were local depositors, children, and older depositors.
These results imply a distribution of losses due to the failure that was catastrophic to the goal of empowering communities of newly freed slaves. Financial intermediaries that allow for on-demand redemption rely on a certain amount of “stickiness” in their depositor base to remain stable. However, our results show that this stickiness manifests more in some groups than others and that these groups are most harmed during a bank failure. Citizens and institutions with stronger community roots created by these groups help facilitate the accumulation of social and human capital within those communities. They are also likely to be most heavily invested in the hope of the bank’s philanthropic mission. Yet because they appear to place greater initial trust in the bank, they disproportionately bear the loss of financial capital in the event of failure.
The results demonstrated here have important implications for policy makers today. While savings and financial participation are important tools for improving welfare and economic integration, their application to poor minority populations comes with significant complications. Since more sophisticated depositors are often able to front-run other depositors and redeem in full prior to failure, this can disproportionately place losses onto communities the these insitutions were established to help. Our results emphasize the uncertain role of unsecured depositors in financial institutions with heterogeneous investors. They also highlight the importance of designing stable financial institutions when trying to encourage financial participation among disenfranchised minority groups.
Osthaus, Carl R. 1976. Freedmen, philanthropy, and fraud: a history of the Freedman’s Savings Bank. Urbana: University of Illinois Press. http://www.worldcat.org/oclc/2177914
Office of the Comptroller of the Currency. The Freedman’s Savings Bank: Good Intentions Were Not Enough; A Noble Experiment Goes Awry. OCC Website
Stein, Luke C. and Constantine Yannelis. Financial Inclusion, Human Capital, and Wealth Accumulation: Evidence from the Freedman’s Savings Bank. The Review of Financial Studies. hhaa013. https://doi.org/10.1093/rfs/hhaa013
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