This essay, the first of a series on government efforts to bank the "unbanked," reviews the history of postal banking and its deleterious role in the Great Depression. Subsequent posts will discuss contemporary proposals for government involvement in retail banking, such as through the U.S. Postal Service and the Federal Reserve, in light of this experience.
Some 8.4 million U.S. households (6.5 percent of the total) have no bank account. For a modern economy, that's a high number. Some experts and politicians believe that the best way to lower it would be to get the U.S. Postal Service to offer bank accounts, with many claiming that America's experience of postal savings between 1911 and 1966 shows how a similar system could help bank today's "unbanked."
Superficial evidence might seem to corroborate their case. Immigrants and minorities make up a disproportionate share of the unbanked, and a recent study found immigrants were particularly heavy users of postal savings in its early years. But most contemporary accounts, especially those that claim postal savings as a model for the present, fail to give due consideration to how a poor legislative design made it a force for ill in the toughest years of the Great Depression. Far from strengthening the argument for post-office banking today, the postal savings experience is a cautionary tale against government participation in activities that have historically been the remit of commercial banks.
The Case for Postal Savings at the Dawn of the Twentieth Century
The aim of postal savings legislation when it passed in 1910 was not unlike the one today's proponents of post-office banking have. It was to offer lower-income Americans "safe and convenient places for the deposit of savings at a comparatively low rate of interest." [Emphasis mine.] The main difference is that, whereas the emphasis today is on access to payment services, back then it was on encouraging thrift.
Proponents of postal savings offered a specific reason for favoring it. More than at any time before or since, America at the dawn of the twentieth century was a nation of freshly arrived immigrants, many of whom came from Italy, Austria-Hungary, and the Russian Empire—all countries with postal banks. Because many of these immigrants were suspicious of ordinary banks, the belief was that they would more eagerly sign up for postal savings, as many of them had done back home.
Not that immigrants' suspicion of U.S. banks was misplaced. The American banking system had long been (and would for decades after remain) fragile and unstable, with periodic panics causing widespread bank failures and significant losses to depositors. While a few sentences cannot make for an adequate exposition of U.S. banks' unique weaknesses, state restrictions on bank branching were the most important cause, as they made the median U.S. bank very small and undiversified.
Although experts at the time disagreed about the best remedy to this problem, few denied its existence. And some saw postal savings as part of the solution. They claimed it would not only reassure new Americans but provide others with a safe alternative to the increasingly failure-prone unit banks that many had had to rely on. By the early 1900s, the idea of postal savings had gained considerable support among Republicans, whereas Democrats tended to prefer government insurance of commercial bank deposit accounts.
Legislating Postal Savings
The 1907 banking panic that ushered in the Federal Reserve System also gave final impetus to postal savings legislation, which President William Howard Taft (an advocate) signed in 1910. The Postal Savings Act established a board of trustees composed of the Postmaster-General, the Treasury Secretary, and the Attorney-General to supervise postal savings accounts. These accounts were made available to any person over ten years of age, with a limit of one account per person. Monthly deposits were limited to $100 (around $2,700 in today's money), and at first account balances could not exceed $500 ($13,500 in 2020). In 1918, the maximum balance was raised to $2,500.
Postal savings accounts paid a fixed interest rate of 2 percent per year—a yield considerably below commercial bank interest rates in 1910. But the funds would still end up with commercial banks: the 1910 Act prescribed that, except for a five percent reserve to be held at the Treasury, the board was to make every effort to re-deposit postal savings funds at solvent national or state banks located near the post offices where deposits were made. This was in keeping with the then-popular but misguided concern to prevent "capital export," which also informed that era's restrictions on bank branching.
The re-deposit requirement was also intended as a sop to commercial banks, which had vigorously opposed postal savings. But there was a catch: re-depositories had to pay 2.25 percent interest (raised to 2.5 percent in 1934) on postal savings sent their way, come-what-may. That requirement made being a re-depository attractive at first. But it would prove disruptive during the Great Depression. Crucially, the 1910 Act excluded savings and loan institutions (S&Ls) from the role of re-depository. Not only that, but because S&Ls were less diversified and marketed themselves as the safer alternative to banks, the competitive threat to them from postal savings was greater.
Impact on Banks' Stability During the Great Depression
The rigidities introduced by the 1910 Act, and its fixed interest rates especially, made the supply of postal savings very sensitive to the business cycle. Fixed postal interest rates encouraged depositors to switch to postal savings during recessions, when commercial bank rates tended to be low, and to do the opposite during booms. But the same rate system also made serving as a postal savings re-depository less attractive during recessions, when the need for them was greatest! This combination of effects was bound to cause trouble, and especially so in any deep recession.
In the absence of government deposit insurance and market-based mechanisms (such as branching and bank consolidation) to reduce bank failure, postal savings became as near a safe haven as depositors had ready access to during panics, of which there were a few in the early years of the Depression. Postal deposits were also arguably a more attractive, because safer, alternative to stuffing one's savings under the mattress. And even though funds withdrawn from banks into postal savings accounts eventually found their way back into banks (unlike funds in "mattress safes"), these were seldom the same banks that had suffered the withdrawals. Therefore, and quite aside from the peace of mind depositors gained thanks to postal savings, its existence could contribute to bank illiquidity when confidence waned.
Bank depositors did withdraw large amounts in the early 1930s, so that by 1933 the number of postal savings depositors had quintupled to 2,300,000 compared to the 1920s, and the amount of funds they held with their local post office had grown eightfold to $1.2 billion—a sum equal to 2.3 percent of total bank deposits, and 5.6 percent of savings deposits, in 1933. Unsurprisingly, postal savings became especially popular in places where many banks failed. (In the 1920s, use of postal savings accounts had been strong in states that both suffered panics and lacked state deposit insurance.) While the average balance per depositor was still well below the $2,500 cap, it nearly doubled in the four years to 1933, from $280 to $507.
The impact of postal deposit growth on banks' stability is unclear. On one hand, the government through the postal savings system effectively acted as a broker-guarantor for bank deposits, taking funds withdrawn from the commercial banking system and re-depositing them into that system with the government's repayment guarantee. Absent postal savings, some of these funds would doubtless have left the banking system entirely, to be stored in safes and under mattresses. To the extent that postal savings was a substitute for such hoarding of cash, it helped to ameliorate banks' funding problems. But the availability of postal savings may also have increased the extent to which people abandoned healthy banks, even when they did not necessarily distrust them, sealing their fate and undermining the banking system's stability.
Apart from seeing their customers flee, bankers resented the strings attached to the government's explicit guarantee of postal savings, in the form of a requirement to post collateral of government and other securities, and to pay out interest at 2.25 (later 2.5) percent. More local banks started to refuse postal deposits, causing a growing share of these deposits to find their way into out-of-state banks and Treasury bonds. Even if the bulk of these funds, including those invested in Treasuries, eventually returned to the banking system, the availability of postal savings may have increased rather than reduced bank fragility in areas affected by panics.
Impact on S&Ls and the Housing Market
Savings and loan institutions were the really big losers from postal savings during the Depression. They experienced massive withdrawals between 1929 and 1934, while postal deposits soared. As early as 1930, a Washington S&L representative complained that "there [was] practically no money available . . . for home financing" because of cash hoarding and postal savings; and by 1938, deposits at S&Ls remained below their 1934 level, which itself was 30 percent lower than the pre-Depression high. The reason for this was that, unlike banks, S&Ls could not act as postal re-depositories.
It is well-known that the housing market took many years and significant government interventions to recover. But most accounts fail to recognize the role of postal savings in delaying the recovery, by increasing people's incentive to withdraw funds from S&Ls, denying them a role as re-depositories, and not putting any funds into housing-related lending until 1934. Banks then faced restrictions on mortgage lending, so even had they wanted to deploy postal re-deposits into mortgages, they could not have fully made up for the retreat of S&Ls. Speculating how differently things might have turned out but for postal savings is risky. Still, perhaps the government-dominated housing finance market that today characterizes the United States (but no other Western country) might not have come to be without the long slump to which postal savings contributed.
Postal Savings as Practical Politics
Subsequent essays will discuss the lessons of postal savings for two contemporary proposals aimed at financial inclusion: post-office banking and Federal Reserve provision of retail deposit accounts, often under the banner of a "central bank digital currency." For now, the most important lesson is that any such proposal is just as likely as postal savings was to become an object of political horse-trading and heavy lobbying by vested interests. And that can turn even desirable interventions into practical disasters.