History of banking in the United States

Overview

This article details the history of banking in the United States. Banking in the United States is regulated by both the federal and state governments.

New nation

In the first half of the 19th century, many of the smaller commercial banks within New England were easily chartered as laws allowed to do so (primarily due to open franchise laws). The rise of commercial banking saw an increase in opportunities for entrepreneurs to borrow capital used to grow an enterprise. The small private banking sector saw a great deal of insider lending. Many of these banks actually spurred early investment and helped spur many later projects. Despite what some may consider discriminatory practices with insider lending, these banks actually were very sound and failures remained uncommon, further encouraging the financial evolution in the United States.

Early attempts to create a national bank

In 1781, an act of the Congress of the Confederation established the Bank of North America in Philadelphia, where it superseded the state-chartered Bank of Pennsylvania founded in 1780 to help fund the war. The Bank of North America was granted a monopoly on the issue of bills of credit as currency at the national level. Robert Morris, the first Superintendent of Finance appointed under the Articles of Confederation, proposed the Bank of North America as a commercial bank that would act as the sole fiscal and monetary agent for the government. He has accordingly been called "the father of the system of credit, and paper circulation, in the United States". He saw a national, for-profit, private monopoly following in the footsteps of the Bank of England as necessary, because previous attempts to finance the Revolutionary War, such as continental currency emitted by the Continental Congress, had led to depreciation of such an extent that Alexander Hamilton considered them to be "public embarrassments". After the war, a number of state banks were chartered, including in 1784: the Bank of New York and the Bank of Massachusetts. During the final decade of the 18th century, the United States had only three banks, while a wide variety of currencies circulated, including English, Spanish, French, and Portuguese coins, as well as paper notes issued by states and local governments. The values of these currencies were approximated and fluctuations in exchange rates were published. While values of various currencies did fluctuate geographically, this was irrelevant in a society dominated by local trades. Ron Michener of UVA discusses the colonial monetary situation in depth. Supporters of the bank argued that if the nation were to grow and to prosper, it needed a universally accepted standard coinage and this would best be provided by a United States Mint, aided and supported by a national bank and an excise tax. Opponents of the bank argued that government monopolization of money was a corrupt exercise that would impoverish the people.

First Bank of the United States

In 1791, Congress chartered the First Bank of the United States. The bank, which was jointly owned by the federal government and private stockholders, was a nationwide commercial bank which served as the bank for the federal government and operated as a regular commercial bank acting in competition with state banks. When depositors brought state bank notes to First Bank of the United States, it would present these notes to the state banks, demanding gold, which hampered the state banks' ability to issues notes and maintain adequate reserves. Consequently, when First Bank of the United States' charter came up for renewal in 1811, it was met with a great deal of opposition from state banks and the renewal legislation was not passed. The Second Bank of the United States opened in January 1817, six years after the First Bank of the United States lost its charter. The predominant reason that the Second Bank of the United States was chartered was that in the War of 1812, the U.S. experienced severe inflation and had difficulty in financing military operations. Subsequently, the credit and borrowing status of the Treasury was at its lowest level ever. Private banking exploded rapidly after the war ended in 1815, culminating in the Panic of 1819.

Jacksonian Era

The charter of the Second Bank of the United States (B.U.S.) was for 20 years and therefore up for renewal in 1836. Its role as the depository of the federal government's revenues made it a political target of banks chartered by the individual states who objected/envied the B.U.S.'s relationship with the central government. Partisan politics came heavily into play in the debate over the renewal of the charter. "The classic statement by Arthur Schlesinger was that the partisan politics during the Jacksonian period was grounded in class conflict. Viewed through the lens of party elite discourse, Schlesinger saw inter-party conflict as a clash between wealthy Whigs and working class Democrats." (Grynaviski) President Andrew Jackson strongly opposed the renewal of its charter, and built his platform for the election of 1832 around doing away with the Second Bank of the United States. Jackson's political target was Nicholas Biddle, financier, politician, and president of the Bank of the United States. Apart from a general hostility to banking and the belief that specie (gold and/or silver) were the only true monies, Jackson's reasons for opposing the renewal of the charter revolved around his belief that bestowing power and responsibility upon a single bank was the cause of inflation and other perceived evils. During September 1833, President Jackson issued an executive order that ended the deposit of government funds into the Bank of the United States. After September 1833, these deposits were placed in the state chartered banks, commonly referred to as Jackson's "pet banks". While it is true that 6 out of the 7 initial depositories were controlled by Jacksonian Democrats, the later depositories, such as the ones in North Carolina, South Carolina, and Michigan, were run by managers who opposed Jacksonian politics. It is probably a misnomer to label all the state chartered repositories "pet banks".

1837–1863: "Free banking" era

Prior to 1837 a bank charter could be obtained only by a specific legislative act, but in 1837, the Michigan Act allowed the automatic chartering of banks that could fulfill the Michigan's chartering requirements so as to no longer require special consent of the state legislature. The following year, New York enacted similar legislation with the Free Banking Act, and other states soon followed. These banks could issue bank notes against specie (gold and silver coins) and the states regulated the reserve requirements, interest rates for loans and deposits, the necessary capital ratio etc. Free banking spread rapidly to other states, and from 1840 to 1863 all banking business was done by state-chartered institutions. While the banking systems of several states were initially unstable, over time financial indicators in most states stabilized. In the early years of free banking in many Western states, the banking industry degenerated into "wildcat" banking because of the laxity and abuse of state laws. Bank notes were issued against little or no security, and credit was overexpanded; depressions brought waves of bank failures. In particular, the multiplicity of state bank notes caused great confusion and loss. The real value of a bank bill was often lower than its face value, and the issuing bank's financial strength generally determined the size of the discount. However, after several years of experience, with the exception of a few exogenous shocks, different states developed more functional and stable banking industries.

National Bank Act

To correct the problems of the "Free Banking" era, Congress passed the National Banking Acts of 1863 and 1864, which created the United States National Banking System and provided for a system of banks to be chartered by the federal government. The National Bank Act encouraged development of a national currency backed by bank holdings of U.S. Treasury securities. It established the Office of the Comptroller of the Currency as part of the United States Department of the Treasury, authorizing it to examine and regulate nationally chartered banks. Congress passed the National Bank Act in an attempt to retire the greenbacks that it had issued to finance the North's effort in the American Civil War. As an additional incentive for banks to submit to Federal supervision, in 1865 Congress began taxing any of state bank notes (also called "bills of credit" or "scrip") a standard rate of 10%, which encouraged many state banks to become national ones. This tax also gave rise to another response by state banks—the widespread adoption of the demand deposit account, also known as a checking account. By the 1880s, deposit accounts had changed the primary source of revenue for many banks. The result of these events is what is known as the "dual banking system". New banks may choose either state or national charters (a bank also can convert its charter from one to the other). At first this new national banking system grew very fast at the expense of state banks, but state banks quickly recuperated as the checking sector began to expand. Additionally, capital requirements for state banks were reduced, which aided their resurgence.

Civil War

During the Civil War, banking houses were syndicated to meet the federal government's need for money to fund its war efforts. Jay Cooke launched the first mass securities selling operation in U.S. history, employing thousands of salesmen to float what ultimately amounted to $830 million worth of government bonds to a wide group of investors. Acting as an agent of the Treasury Department, Cooke then reached out to the general public and personally led a war bond drive that netted approximately $1.5 billion for Treasury.

Surging demand for capital in the Gilded Age

The rise of the commercial banking sector coincided with the growth of early factories, since entrepreneurs had to rely on commercial banks in order to fund their own projects. Because of this need for capital, many banks began to arise by the late 19th century. By 1880, New England became one of the most heavily banked areas in the world. Lance Davis has demonstrated that the process of capital formation in the 19th century was markedly different between the British capital market and the American capital market. British industrialists were readily able to satisfy their need for capital by tapping a vast source of international capital through British banks such as Westminster's, Lloyds and Barclays. In contrast, the dramatic growth of the United States created capital requirements that far outstripped the limited capital resources of American banks. Investment banking in the United States emerged to serve the expansion of railroads, mining companies, and heavy industry. Unlike commercial banks, investment banks were not authorized to issue notes or accept deposits. Instead, they served as brokers or intermediaries, bringing together investors with capital and the firms that needed that capital.

Bimetallism and the gold standard

Bimetallism became a center of political conflict toward the end of the 19th century. To finance the Civil War, the U.S. switched from bimetallism to a flat greenback currency. In 1873, the government passed the Fourth Coinage Act and soon resumption to specie payments began without the free and unlimited coinage of silver. This put the U.S. on a mono-metallic gold standard. This angered the proponents of monetary silver, known as the silverites. They referred to this act as "The Crime of '73", as it was judged to have inhibited inflation. The Panic of 1893 was a severe nationwide depression that brought the money issue to the fore. The "silverites" argued that using silver would inflate the money supply and mean more cash for everyone, which they equated with prosperity. The gold advocates countered that silver would permanently depress the economy, but that sound money produced by a gold standard would restore prosperity.

Bimetallism and "Free Silver" were demanded by William Jennings Bryan who took over leadership of the Democratic Party in 1896, as well as the Populist and Silver Republican Parties. The Republican Party nominated William McKinley on a platform supporting the gold standard which was favored by financial interests on the East Coast. A faction of Republicans from silver mining regions in the West known as the Silver Republicans endorsed Bryan. Bryan gave the famous "Cross of Gold" speech at the National Democratic Convention on July 9, 1896. However, his presidential campaign was ultimately unsuccessful; this can be partially attributed to the discovery of the cyanide process by which gold could be extracted from low-grade ore. This increased the world gold supply and caused the inflation that free coinage of silver was supposed to bring. The McKinley campaign was effective at persuading voters that poor economic progress and unemployment would be exacerbated by adoption of the Bryan platform.

Early 20th century

During the period from 1890 to 1925, the investment banking industry was highly concentrated and dominated by an oligopoly that consisted of JP Morgan & Co.; Kuhn, Loeb & Co.; Brown Brothers; and Kidder, Peabody & Co. There was no legal requirement to separate the operations of commercial and investment banks; as a result deposits from the commercial banking side of the business constituted an in-house supply of capital that could be used to fund the underwriting business of the investment banking side.

The Panic of 1907 and the Pujo Committee

In 1913, the Pujo Committee unanimously determined that a small cabal of financiers had gained consolidated control of numerous industries through the abuse of the public trust in the United States. The chair of the House Committee on Banking and Currency, Representative Arsène Pujo, (D–La. 7th) convened a special committee to investigate a "money trust", the de facto monopoly of Morgan and New York's other most powerful bankers. The committee issued a scathing report on the banking trade, and found that the officers of J.P. Morgan & Co. also sat on the boards of directors of 112 corporations with a market capitalization of $22.5 billion (the total capitalization of the New York Stock Exchange was then estimated at $26.5 billion). Attorney Samuel Untermyer who headed the 1913 Pujo Money Trust Investigation Committee to investigate money trusts defined a money trust to George Baker during the Pujo hearings; "We define a money trust as an established identity and community of interest between a few leaders of finance, which has been created and is held together through stock-holding, interlocking directorates, and other forms of domination over banks, trust companies, railroads, public service and industrial corporations, and which has resulted in vast and growing concentration and control of money and credits in the hands of a few men". The Pujo Committee Report concluded that a community of influential financial leaders had gained control of major manufacturing, transportation, mining, telecommunications and financial markets of the United States. The report revealed that no less than eighteen different major financial corporations were under control of a cartel led by J.P Morgan, George F Baker and James Stillman. These three men, through the resources of seven banks and trust companies (Banker's Trust Co., Guaranty Trust Co., Astor Trust Co., National Bank of Commerce, Liberty National Bank, Chase National Bank, Farmer's Loan and Trust Co.) controlled an estimated $2.1 billion. The report revealed that a handful of men held manipulative control of the New York Stock Exchange and attempted to evade interstate trade laws. The Pujo Report singled out individual bankers including Paul Warburg, Jacob H. Schiff, Felix M. Warburg, Frank E. Peabody, William Rockefeller and Benjamin Strong Jr. The report identified over $22 billion in resources and capitalization controlled through 341 directorships held in 112 corporations by members of the empire headed by J.P. Morgan. The findings of the committee inspired public support for ratification of the Sixteenth Amendment in 1913, passage of the Federal Reserve Act that same year, and passage of the Clayton Antitrust Act in 1914. They were also widely publicized in the Louis Brandeis book Others People's Money--and How the Bankers Use It.