The Financial Interconnectedness of Railroads and the Transmission of Financial Distress during the Great Depression

This paper studies the systemic importance of railroads through the widespread holdings of their bonds by American fiduciary institutions during the Great Depression. We examine the impact of a series of large railroad bond prices shocks using a remarkable data set of the individual bonds held by each Massachusetts savings bank annually. We suggest that the shocks varied across banks for reasons that are largely random relative to the other factors affecting these banks businesses, first because strict regulation prevented bank managers from gambling on particularly risky bonds, and second because the railroads were located outside of Massachusetts. The results suggest that the bond price declines caused banks to engage in greater contraction of their real estate loans, especially if they were also experiencing liquidity problems from deposit withdrawals. Contact information: [email protected] and [email protected]. Both authors are affiliated with the Federal Reserve Board of Governors. We thank Becky Zhang for excellent research assistance. The views expressed here are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System.