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Banking in the United States Before 1914 1

BANKING IN THE UNITED STATES BEFORE 1914 1. The First and Second Banks of the United States. f 2. Bank ing from 1836 to 1863. § 3. National Banking Associations, 1863 1913. I 4. Defects of our banking organization before 1911 § 5. Lack of system. § 6. Inelasticity of credit. § 7. Periodical local con gestion of funds. § 8. Unequal territorial distribution of banking facilities. § 9. Lack of provision for foreign financial operations.

10. The "Aldrich plan." § 1. The First and Second Banks of the United States. The form of our present banking system has been affected by various economic and political events, a knowledge of which is helpful to an understanding of the present banking system in our country.

Alexander Hamilton, the great first Secretary of the Treas ury in Washington's cabinet, advocated the charter of a cen tral national bank as one portion of his larger plan of na tional financiering. His purpose was realized in the charter ing, in 1791, of the First Bank of the United States for a period of twenty years. The capital for this institultion was in small part subscribed by the government, but mostly by private capitalists. The management of the bank was left almost entirely in private hands. The central bank estab lished branches in many parts of the country, issued bank notes which circulated everywhere without depreciation, acted as the governmental depository of funds and as governmental agency in various ways. It seems to have been successful and useful as a banking institution until the expiration of its charter in 1811, but it was touched by the contemporary con troversies over state rights and was from the first opposed by those who feared the growth of a strong central government. This opposition prevented the extension of its charter.

In 1816, however, after only a moderate discussion, the Second Bank of the United States was chartered for a period of twenty years. This, also, in its purely banking aspects, seems to have been distinctly successful, conducting numerous branches in various parts of the country, maintaining at all times the parity of its notes, facilitating domestic exchange throughout the country, and enjoying unquestioned credit and solvency. However, this bank became, even in a greater de gree than did the First Bank, the creature of political rival ries. In the period of rising democratic sentiment typified and led by Andrew Jackson, the bank came to be looked upon as the embodiment, or the stronghold, of plutocratic interests. Jackson's suspicions and hostility to a central bank were magnified by the untactful conduct of the head of the bank, and Congress permitted its charter to expire by limitation in 1836, near the close of Jackson's.administra tion. In the light of history the change of policy must be pronounced unfortunate, the more so because it committed the then leading political party to opposition against a bet ter organization of banking on a national scale. The action was directly that of Jackson, but the fixing of the blame is not an entirely simple thing.

§ 2. Banking from 1836 to 1863. The federal govern ment, which up to that time had deposited its funds in the central bank and its branches, and in local state banks, es tablished the "independent treasury" in 1840. This was abolished in 1841, but reestablished in 1846, and continuously maintained until January, 1921, when the Federal Reserve Board took over all nine of the offices and sub-treasury branches. By this plan the government kept its money of all kinds in various depositories (or sub-treasuries) in charge of public officials. While from 1792 to 1836 almost con tinuously a central banking system was in operation. other banks, organized under state charters, were steadily increas ing in number. They received deposits, issued bank-notes under state laws, and cared for local commercial needs. The abolition of the central national bank in 1836 left to the various state-chartered banks for twenty-seven years all the banking functions of the country. A few of the states be came stockholders in central state banks, or even undertook to conduct a banking business, with unsatisfactory results. The banks of some states (notably those of New England and New York), conducted as private enterprises under care ful regulation and held to strict standards by public senti ment, for the most part maintained a high credit; but many banks, under lax laws and regulations, were guilty of great abuses of credit and of downright dishonest practices. The evils were more especially apparent in connection with exces sive issues of bank-notes.

§ 3. National Banking Associations, 1863-1913. No further step was taken in federal legislation until 1863, when, in the midst of the Civil War, local "national banking asso ciations" were chartered. The purpose was in part. to pro vide banks under national charters for banking purposes (both of deposit and of issue), and in part it was to make a wider market for United States bonds at a time when govern ment credit was at low ebb. The plan adopted followed the experience of New York state (from 1829 on) with a system of bond-secured banknotes. Congress provided that every bank taking out a national charter must purchase bonds of the United States and deposit them with the Treasurer of the United States, in return for which it would receive bank notes to the amount of 90 per cent of the denomination or of the market value of the bonds, whichever was the smaller. (In 1900 this was changed so that notes could be issued to the full amount of the denomination of the bonds.) Notes of failed banks or of banks that go out of business are re deemed from the guaranty fund held at Washington and from the proceeds of the sale of the bonds. Bank-notes issued on this plan, being secured by the bonds and a redemption fund, rest ultimately on the credit of the government, not on the credit of the bank. They are not promptly sent back for redemption to the banks issuing them, as should be done if they were typical bank-notes. They may circulate thousands of miles away from the bank that issued them, and for years after the bank has gone out of business. They are perfectly safe for the holder, but are not an "elastic cur rency," increasing or diminishing with the needs of business. The changes in their amount depend upon the chance of the banks to make more or Tess in this way than by any other use of their capital, and this in turn depends largely on the price of bonds and on the rate of interest they bear. From 1864 to 1870 fortunes were made from this source, but there after banks could make little more from note issues than they could by investing the same amount in other ways. Many banks for a long period did not avail themselves in the least of their privilege of issue. The notes were subject to a A national bank (as the law now stands) may be organized, with $25,000 capital in towns not exceeding three thousand population, with $50,000 in towns not exceeding six thou sand, with $100,000 in cities not exceeding fifty thousand, and with $200,000 in large cities. Three cities, New York, Chicago, and St. Louis, have long been designated as central reserve cities, and some forty-seven other cities as reserve cities, in which the reserves of banks have always been re quired to bear a considerably larger proportion to their de posits than in other Other banks might, until 1914, count as part of their legal reserves their deposits in reserve 1 In recent years that has been one half of 1 per cent when 2 per cent bonds and 1 per cent when bonds bearing a higher interest were deposited.

2 In reserve cities 25 per cent and in other cities 15 per cent. The details of the regulations in the old law (given in part below, I 7) were all altered by the legislation of 1913, effective late in 1914.

city banks, up to a certain proportion. The national banks in the larger cities thus became the great capital reservoirs of cash for the whole country.

National banks have been subject to stricter inspection than have been the banks in most of the states, a fact that has strengthened public confidence in their stability. Except in this and the other respects above mentioned, a national char ter offered few, if any, attractions to small banks, a majority of which have found it more advantageous to operate under state charters because of less stringent regulations as to amount of capital, reserves, and supervision.

§ 4. Defects of our banking organization before 1913. Taken altogether, the national banks in the United States between 1863 and 1913 represented great banking power and very efficient service for the community in times of normal business, as with few exceptions did also the state banks. But in several respects it long ago became apparent that our banks were operating less satisfactorily than those of several other countries. American banking organization had failed to keep pace with the increasing magnitude and diffi culty of its task. Especially at the recurring periods of financial stress, such as those of 1873, 1893, 1903, and 1907, our banking machinery showed itself to be wofully unequal to the strain put upon it. Financial panics were more acute here than in any other land, and this fact clearly was trace able in large part to defects in the banking situation. In academic teaching and in public conferences of bankers, busi ness men, publicists, and students, the subject was continually discussed after 1890. At length Congress in 1908 created a "National Monetary Commission" to inquire into and report what changes were necessary and desirable in the monetary system of the United States or in the laws relative to bank ing and currency. After the most extended inquiry and dis cussion that the subject had ever received, the commission submitted its report in January, 1912. The defects to be remedied, as enumerated in the reports may be reduced to the following five headings: (a) Lack of system. (b) In elasticity of credit. (c) Periodic local congestion of funds.

(d) Unequal territorial distribution of banking facilities.

(e) Lack of provision for foreign banking.

§5. Lack of system. Only in a loose sense could the banks of the United States be said (before 1914) to constitute a system at all. Both national and state laws dealt with indi vidual banks only. It was not legal for a bank to establish

branches in another city, as is done in most countries. The several national banks in one city were legally quite separate. It was only by voluntary agreement that in some of the larger cities they came together into clearing-house associations. They made possible some measure of cooperation which, small as it was, proved at times of stress to be of much service within a limited sphere for the local communities. But even with the aid of these organizations the banks were unable in times of emergency to avoid the suspension of cash payments.

There was no provision whatever for the concentration of bank revenues so that each bank would be supported by the strength of the other banks if a movement began to withdraw deposits in unusual amounts. Each bank then was compelled for self-protection to call for any sums it had deposited with other banks,' and to keep for its own use all the reserves it might have in excess of its own immediate needs. This threw a great strain upon the banks in the reserve 'cities, which in normal times had become the depositories of a good part of the reserves of the banks in other places. Thus de veloped a spirit of panic, like the fright of theater-goers crowding toward the door at the cry of fire.

The maintenance of the government's independent treasury contributed to the difficulties by causing the irregular with drawal of money from circulation and thus depleting bank 3 The expressions within quotation marks in the following sections are taken from this report.

reserves in periods of excessive government revenues and by returning these funds into circulation only in periods of deficient revenues. Efforts to modify this system by a partial distribution of the public moneys among national banks, had resulted, it was charged, in discrimination and favoritism in the treatment of different banks and of different sections of the country.

§ 6. Inelasticity of credit.

Our banks, considered both separately and collectively, were unable to increase their lend ing powers quickly and easily to respond to business needs. The need of greater elasticity of credit was felt in the more or less regular seasonal variations within the year, and in the more irregular variations in cycles of years from periods of prosperity to those of panic and depression in business. The inelasticity was necessitated by illogical federal and state laws restricting absolutely the further extension of credit when the reserves fell below the percentage of deposits (15 or 25 per cent) fixed by law. Reserves thus could not legally be used to meet demands for cash payments at the very time when most needed. This feature has been likened to the rule of the prudent liveryman who always refused to allow the last horse to leave his stable so that he would never be without a horse when a customer called for one. The refusal of credit by the banks at such times when they still had large amounts of cash in their vaults increased the need and eagerness of the public to draw from the bank all the cash they could, and often precipitated the insolvency of the banks. Clearly, some means were needed to enable the lending power of the indi vidual banks to be increased at such times, so that no customer with good commercial paper need fear to be refused a loan even though the rate of interest might have to be somewhat higher for a few days or weeks than the normal rate.

Our bond-secured bank-notes lacked almost entirely the quality of elasticity needed to meet these changing business needs.' Their value being dependent primarily upon the I See above, 1 3.

amount and price of United States bonds, they might be most numerous just when least needed as a part of our circulating medium.

§ 7. Periodical local congestion of funds. In times of general confidence each bank finds it profitable, and is tempted, to extend its credit to the extreme limit permitted by the law governing the proportion of reserves to deposits. Of the 15 per cent reserves that were required in the so-called "country" banks, three fifths (9 per cent) might be kept in banks in reserve cities; and of the 25 per cent in reserve city banks, per cent might be kept in central reserve cities. There it counted as part of the depositing banks' legal reserves, was a fund upon which domestic exchanges could be drawn, and earned a small rate of interest (usually 2 per cent) paid by banks in reserve and central reserve cities to their "country" correspondents. By this process of pyramiding, reserves in very large part came to be kept in New York city, where they could be lent "on call," and the largest use for call loans was in stock-exchange specula tion. Thus every period of prosperity encouraged an un healthy distribution of reserves, gave an unhealthy stim ulus to rising prices, and "promoted dangerous specula tion." § 8. Unequal territorial distribution of banking facilities. Another aspect of this concentration of surplus money and available funds in the larger cities was the comparatively ample provision of banking facilities in the cities and in the manufacturng sections, and imperfect provision in the agri cultural districts. The whole financial system seemed de signed to induce the poorer country districts to lend tempo rarily available funds at low rates of interest to be used speculatively in cities, instead of enabling the richer districts, the cities, to lend to the rural districts for productive enter prise. The rates of bank discount in different sections of our country have long been most unequal—lowest in the largest cities and highest in the rural South and West—whereas in Canada, with a different system of banking, the rates have long been much more approximately uniform in urban and agricultural districts.

Indeed, our national banking development has been pre dominately urban and commercial to the neglect of rural and agricultural interests. National banks were (until 1913) for bidden to make loans on real estate, and this greatly "re stricted their power to serve farmers and other borrowers. in rural communities." There was in the more agricultural regions, "no effective agency to meet the ordinary or unusual demands for credit or currency necessary for moving crops or for other legitimate purposes." The lack of uniform stand ards of regulation, examination, and publication of reports in the different sections prevented the free extension of credit where most needed. Finally, the methods and agencies for making domestic exchange of funds were, compared with other countries, imperfect and uneconomical even in normal times, and could not "prevent disastrous disruption of all such exchanges in times of serious trouble." § 9. Lack of provision for foreign financial operations. Not without its influence on public opinion was the considera tion that we had "no American banking institutions in for eign countries." Many bankers and business men felt, as did the Commission, that the time had come when the organiza tion of such banks was "necessary for the development of our foreign trade." Foreign banks in South America and the Orient, handling American trade, were believed to favor their own countrymen rather than the interests of American mer chants. In contrast with the European nations with their centralized control of banking, we had "no instrumentality that" could "deal effectively with the broad questions which, from an international standpoint, affect the credit and status of the United States as one of the great financial powers of the world. In times of threatened trouble or of actual panic these questions, which involve the course of foreign exchange and the international movements of gold, are even more im portant to us from a national than from an international standpoint." §10. The "Aldrich plan." The report of the National Monetary Commission represented most careful study of the whole subject, and embodied the efforts and aid of many of the best financial experts of this and other lands. The Com mission in its work gave an admirable example of the right way to prepare for and undertake important economic legis lation. Though it discovered nothing essential that was not known to the small group of expert economic students, it put all material into systematic and convincing form and served during several years to educate public opinion as to the needs and proper means of sound banking policy. The analy sis of difficulties as outlined above has not merely a tempo • rary but a lasting interest to the student of financial history, for it implies an ideal for the banking system of the nation.

The Commission submitted with its report a constructive plan which was known by the name of the Commission's chairman, Senator Aldrich. This plan was embodied in a bill for a National Reserve Association, a bank for banks, which bore some likeness to the great central banks of Europe. In the many details of the plan an effort was made to remedy every one of the difficulties above described and to supply all the needs indicated. The plan was favored pretty gen erally by bankers, but called forth many adverse opinions. In the year of a presidential election, however, Congress took no action in the matter. All parties were pledged to some kind of banking reform, but particular proposals were not discussed in the campaign.


National Monetary Commission, Report. 1912. In Sen. Doc. 243, 62d Cong., 2d Cess.

Phillips, C. A., ed., Readings in money and banking. N. Y. Mac millan. 1916. Ch. XXX.

United States Comptroller of the

Currency, Annual reports.

White, Horace, Money and banking illustrated by American History. Bost. Ginn. 1914. Bk. III, chs. IV, XV, XVII, XX, XXI, and appendices A and B.

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