Banking and Finance

Banking and Finance. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the Bank of North America in 1781. It lent money to the cash‐strapped Revolutionary government as well as to private citizens and served as a model for later commercial banks. Like the Bank of North America, most early banks lent money conservatively. Most such banks, which were chartered by the states to serve the public interest, were also partly state‐owned.

Banking grew in tandem with population and trade, and the post–1800 period witnessed an explosion of banks. By 1818, 338 banks provided short‐term credit for merchants, artisans, and farmers. By then banks had lost much of their public‐interest function, and had become instead primarily profit‐making enterprise. Political leaders, while bowing to the public's clamor for more credit, grew concerned over the monetary consequences of easy money. Many banknotes traded at substantial discounts, and some were not accepted at any price, leaving many citizens with worthless paper.

The First and Second Banks of the United States.

The first Bank of the United States (BUS) mitigated some monetary problems. Granted a twenty‐year charter by Congress in 1791, it acted as both a commercial bank and the government's fiscal agent. Proposed by Hamilton, the bank was based in Philadelphia with branches in eight other cities; it was well managed but widely criticized by those seeking easier credit for unduly restraining state bank lending. Opponents succeeded in defeating the bank's recharter in 1811.

Difficulties in financing the War of 1812 demonstrated the value of a national bank, and in 1816, granted the second BUS a twenty‐year charter. Modeled after its predecessor, the Second BUS also engaged in commercial and central bank activities. Philadelphia's Nicholas Biddle, assuming leadership of the bank in 1823, built it into a powerful institution by requiring each of its branches to play a defined role within a national economy as determined by the central bank in Philadelphia. The second BUS also proved an effective regulator of note issues and lending by the 464 existing state banks. But Biddle's policies roused opposition, and by 1832, when the Whig party leader Henry Clay, a BUS supporter, ran for president opposing Andrew Jackson's reelection bid, the bank's recharter became a political flashpoint. Congress approved the renewal, but Jackson vetoed it in July 1832 and interpreted his reelection that November as broad support for his antibank stance. He removed federal deposits from the BUS, and its charter expired in 1836.

The resulting void in financial markets was filled by the rapid expansion of state banks. By 1860, the nation's 1,562 banks held $422 million in capital. This era, commonly referred to as the “free banking era,” ended in 1863 with passage of the National Bank Act. Proposed by treasury secretary Salmon P. Chase, the act invited state banks to obtain a federal charter. Designed to assist Civil War finance and end currency chaos, the act required national banks to buy government bonds and deposit them with the U.S. Treasury, which issued banknotes equal to 90 percent of the value of the collateral bonds. The act generated a uniform national currency, nicknamed greenbacks, and protected banknote holders from loss. When a bank failed, the treasury sold its bonds and reimbursed banknote holders. The act also imposed reserve requirements and minimum capital requirements on member banks.

Because the high costs of a national charter, many state banks remained independent, and the system grew slowly. In 1865, Congress imposed a 10 percent tax on state banknotes, leading more state banks to accept national charters. Although the number of national banks increased after 1865, state banks continued to outnumber national banks, and the aggregate volume of deposits in each remained nearly equal. A federal charter imposed other liabilities on member banks, including a prohibition on real‐estate lending; an arbitrary ceiling on aggregate note issues; and rules preventing banks from increasing note issues in a timely manner in response to short‐term changes in the demand for currency. The last two features created an inelastic currency; seasonal pressures in the money market; and a proclivity to financial panics, bank runs, and suspension of payments.

The Federal Reserve Act and the Glass‐Steagall Act.

Following a financial panic in 1907, Congress commissioned studies of contemporary and historical banking systems. Most of these studies criticized systems lacking a strong central bank. In response, Congress passed the Federal Reserve Act in 1913. The Federal Reserve System divided the country into twelve districts, each with a Reserve Bank and one or more branches. Reserve Banks were organized as federally chartered corporations owned by member banks. Members included all national banks and those state institutions that chose to join.

The Reserve Banks became the principal medium for carrying out the credit and monetary policies of the Federal Reserve System, as well as its general regulatory policies and supervisory powers. Reserve Banks hold the required reserves of member banks and provide check‐clearing and settlement services for them. The Reserve Banks also act as fiscal agents and depositories for the U.S. Treasury and other federal government units. A seven‐member Board of Governors of the Federal Reserve System, appointed by the president and located in Washington, D.C., administers the twelve Reserve Banks and their branches. The system's prime policy arm is the Federal Open Market Committee, which meets about twenty times each year to set monetary policies designed to combat inflation, limit unemployment, and promote economic growth.

The Federal Reserve's inability to prevent banking panics and widespread closings during the Great Depression of the 1930s exposed several weaknesses. President Franklin Delano Roosevelt provided a stopgap solution by declaring a national bank holiday in March 1933, which slowed internal drains of reserves. Banks were not allowed to reopen until they had been inspected and recertified by state or federal auditors. Roosevelt also suspended the gold standard to halt the external drain of reserves.

The failure of several thousand banks and the loss of millions to bank depositors during the Depression prompted Congress to pass legislation designed to recapitalize and restore public confidence in the nation's financial intermediaries. The Federal Home Loan Bank System and the Federal Savings and Loan Insurance Corporation (FSLIC), both established in 1932, assisted the savings and loan industry and promoted home ownership. More significant, perhaps, was the Glass‐Steagall Act of 1933, which established the Federal Deposit Insurance Corporation (FDIC). The FDIC protects depositors against bank failures. All national banks and member banks of the Federal Reserve System are required to join. State banks that meet prescribed conditions may be admitted.

Banking in the Late Twentieth Century.

Until the early 1980s, the federal regulatory system in conjunction with bank and thrift insurance limited bank failure to just a handful each year. In the 1980s, however, the failure of about five hundred savings and loans as well as several large commercial banks effectively bankrupted the FSLIC, and its unmet obligations required taxpayers to subsidize its shortfall of more than $100 billion.

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 reformed and recapitalized the federal deposit insurance programs. The FSLIC was closed and its supervisory powers transferred to the Office of Thrift Supervision. Its insurance function was shifted to the FDIC, which became the principal regulator of the nation's banks.

By 1998, the nation's 10,481 commercial banks and 1,687 savings banks held deposits of more that $5 trillion. The two largest U.S. banks were Citigroup, Inc., of New York City and BankAmerica Corporation of San Francisco, with assets of $6.8 billion and $6.2 billion, respectively. As in other areas of the economy, a series of mergers and acquisitions, producing ever‐larger banking conglomerates, characterized the industry in the late twentieth century. The rise of the computer and electronic data transfer, as well as the economic globalization and the growth of multinational enterprises, had profound effects for banking as well. A major piece of reform legislation, the Financial Services of 1999, repealed parts of the Glass‐Steagall Act and enabled banks to provide a broader array of financial services and more easily to merge with insurance and securities companies.
See also Antebellum Era; Depressions, Economic; Early Republic, Era of the; Economic Development; Federal Government, Executive Branch: Department of Treasury; Free Silver Movement; Greenback Labor Party; Monetary Policy, Federal; Morgan, J.P.; New Deal Era, The; Populist Era; Populist Party; Progressive Era; Savings and Loan Debacle.

Bibliography

Bray Hammond , Banks and Politics in America from the Revolution of the Civil War, 1957.
Milton Friedman and and Anna J. Schwartz , A Monetary History of the United States, 1867–1960, 1963.
Richard Sylla , The American Capital Market, 1846–1914, 1975.
John A. James , Money and Capital Markets in Postbellum America, 1978.
Eugene Nelson White , The Regulation and Reform of the American Banking System, 1900–1929, 1983.
Edward J. Kane , The S&L Insurance Mess, 1989.
Naomi R. Lamoreaux , Insider Lending, 1994.
Elmus Wicker , The Banking Panics of the Great Depression, 1996.
Howard Bodenhorn , A History of Banking in Antebellum America, 2000.

Howard Bodenhorn