The History of Banking in the United States - Research Paper Example

?Banking and banks are not new to history, whether it is the history of the United Sates or the history of the world. The first transactions exist inancient history, without written records, in a time before the arguments of recessions and depressions, before the complexities of a Federal Reserve existed or any sort of a national banking system. At its core, a bank, no matter at what place in history or where it is located, does the same thing: it deals with taking in, recording, and giving out money. It is ironic to note that, upon the celebration of the United States of America gaining their independence from England, there was no bank in existence in the former colonies. As colonies of England, they had fallen under the Bank of England, and used the British forms of money, as their legal tender (Rothbard 47). Far more common, however, was trade in the form of barter of items, such as beaver fur and wampum, as well as tobacco and rice (Rothbard 48). Called “commodity money”, it served the needs of the colonists during trade with each other, especially in outlying rural areas; however, an actual legal tender was needed, it was found, when trading in cities or in a foreign market with other countries. Thus the newly-formed states were forced to bring in money from other countries to act as their own currency; before long, Spanish doubloons competed alongside French, Portuguese, and Brazilian coins for tender (Rothbard 49). This controversy was solved when, in 1781, the Bank of North America was founded by Roger Morris in Philadelphia (Foster 176). As the first bank established on the new soil, its primary aim was to finance the American Revolution, as well as economize the use of cash. Its primary aim was to do this by using the money that it was paid by depositors as loans to others, often at two or three times the amount of cash on hand (Foster 176). It succeeded admirably in both areas, making loans to not only the government but private citizens, and was quickly followed by more banks. To stay out of the limelight of the raging debate of whether or not Congress had the power, under the Articles of Confederation, it procured a charter from the State of Pennsylvania, which was continuously renewed until the bank entered the national banking system (Foster 178). This bank was quickly followed by other banks, including the Bank of Massachusetts, established in 1784, the Bank of New York, also founded in 1784, and the Bank of the Manhattan Company, founded by Aaron Burr under the disguise of a company that was to supply pure water to New York City (Foster 179). While all of this was going on, a debate was raging in the new Congress. Alexander Hamilton, Secretary of the Treasury, called for a national bank, stating it was needed to manage the government money and to regulate the credit of the nation (Johnson 7). Thomas Jefferson argued that there was no provision for a national bank in the U.S. Constitution, therefore it was not within the power of Congress to create one (Johnson 7). Hamilton, after lengthy discussions on the fact that the new government had created fiscal powers in the past, and therefore owed it to the people to exercise some control over them, won the argument and the First Bank of the United States was created in 1791 (Johnson 8). The First Bank of the United States operated much like the banks of today, though perhaps on a different scale, as online banking (and the internet) was a long way from being invented. The bank was made of shareholders that had pledged money to the bank and could vote on decisions and other matters, and took in money from others, while giving out loans (Foster 180). They could lend money for mortgages, but could not hold real estate, and while loans could be made, they were limited to an amount equal to the capital stock of the bank, which was $10,000,000 when started, with directors being held personally liable for any debt over the amount of capital (Foster 181). The First Bank of the United States was a great success, and might have continued that way if the charter had not run out in 1811. Though its power was useful to American commerce, the bank actually frightened many people who were not comfortable with the power that the federal government had in the bank. By and large, the American public went about fearing another reprise of oppression like that which they had just escaped from in gaining their independence from the Bank of England (Rothbard 71). Many thought that the bank was a great monopoly controlling the money of America, especially the state banks, and the new charter of the bank failed by one vote each in the House and the Senate (Rothbard 71). The War of 1812, rather than strengthening and uniting the banking system of the states, caused disarray and confusion, tearing it apart. With the loss of the First Bank of the United States, a “mushroom growth” of state banks happened throughout the country, many of whom issued large quantities of notes that they (each bank) could not hope to pay back to the average person (Foster 183). Compounding this problem was the fact that it was difficult to tell what any bank note was worth, there was a wide variety of currency with widely differing values, and without a federal bank, counterfeiting was easy (Brinkley 202). Those that had originally thought that things would be easier without a federal bank quickly changed their minds, even those that had voted against the bank originally. Thomas Jefferson and even the current president at the time, John Madison, who had both insisted previously that Congress did not have the power to create such a bank, now saw their error (Davidson, and Stoff 312). Both quickly changed their support to a law which would charter a second bank, and hoped that by lending money to individuals and restoring order to the money supply, American businesses would then grow and sustain the economy (Davidson, and Stoff 312). Therefore, to solve the problems of differing money and inflation, a new central bank, the Second Bank of the United States, was created in 1816. Modeled closely after the first bank but with much more capital ($35,000,000 instead of $10,000,000), the Second Bank of the United States had the primary goals of creating a national paper currency, purchasing a large chunk of the public debt that had been created when the large quantities of notes were produced and issued by state banks, as well as to receive deposits of government, or Treasury, funds (Rothbard 83). It was granted an exclusive charter for 20 years, and while it did not have the power to compel the state banks to stop issuing their own notes, its size and power enabled it to compel the state banks to issue only sound notes (those that would not be worthless), or the state banks would risk being forced out of business (Brinkley 202). In 1829, when the bank was at its height of popularity and strength, Andrew Jackson became President. Already suspicious of any bank or central place where money was held, he readily gave an ear to reports made to him by friends that told him of the bank using its influence against him politically (Foster 184). Nicholas Biddle, President of the Bank since 1823, flatly denied any claims of this, and stated that “the federal government had nothing to say about the management of the bank” (Foster 185). Obviously, with President Jackson already upset, this did little but displease him more, to the point where he became determined to destroy the “monster” that he saw the bank becoming. Though he could not legally abolish the bank before the expiration of its charter, he weakened it substantially by ordering the Secretary of the Treasury to remove from it all Treasury notes and government deposits, which the bank had had a monopoly on, and place them in certain state banks, which came to be known as “pet banks” (Brinkley 236). In the end, after a bitter verbal and political war between himself and Jackson, Biddle drafted the Bank Bill, which would renew the charter of the bank early, but found himself promptly vetoed by an angry Jackson who declared the Bank unconstitutional (despite a Supreme Court ruling in its favor), and citing again the “monster” viewpoint and theories of what the bank had become (Davidson, and Stoff 335). Without a new charter, the Bank effectively received a death sentence and closed its doors in 1836. The closing of the bank in 1836 caused a panic and nationwide depression in which many banks failed. With the stability of the federal bank, most people, including land speculators, had purchased land and goods on credit, and now that the stability of a central bank was gone, they were faced with bills that they could not pay. Making matters worse, many rushed to banks to collect their deposits, only to be told that there was no money to give to them (Davidson, and Stoff 342). It did not help matters that the new President Martin Van Buren, who had succeeded Jackson in March of 1837, thought a hands-off approach was better, stating that “the less the government interferes with private pursuits, the better for the general prosperity.” (Davidson, and Stoff 342). During the period of time from the 1830’s to the Civil War, state banks once again were the order of business in the United States, creating a system known as “free banking”. With the financial system in virtual freefall, the Free Banking Law of 1838 authorized any person or persons who purchased the necessary securities (which, at that time, were government bonds or secured mortgages), to open a bank, and issued them circulatory notes equal to the amount of their opening deposit in starting their bank, to be used as money (Foster 190). Intending to insure the owner against loss, the notes failed miserably, almost as miserably as the free banking system itself. Over 130 new banks were organized before 1840, and bank failure was high, along with the secondary problem of the notes, in many cases, not being sufficient to cover their losses (Foster 191). Though many states tried many different methods to make state banking work, despite local differences, the system never quite achieved the power that the national bank had held. The one, lone exception to this was the Suffolk Bank. Established in the chaos of New England flooded by country banks, each with their own separate banknotes, the Suffolk Bank made itself an agent of redemption for all banknotes, which would be redeemed at face value no matter which bank they came from, provided a small deposit was made with the notes to cover their costs (Foster 188). As such, The Suffolk Bank strengthened its position among all country banks, and all banks in New England became members of the Suffolk system, which lasted until the National Banking Act was passed (Foster 188). The National Banking Acts of 1863-1864 brought order and unity back to the American banking system in that they destroyed the issue of bank notes by state-chartered banks and then monopolized the issue of bank notes in the hands of a few federally chartered “national banks”. To become a national bank and receive a charter, all a state bank had to do was to have enough capital and be willing to invest one-third of it in government securities. In return, they would receive the privilege of issuing United States Treasury notes as currency (Brinkley 366). Though an additional amendment was needed in 1865, which would slap state banks with a 10% tax on all state notes if they did not cease to issue them and convert to the national banking system, eventually banks did convert, and the banking system was again stabilized under the National Banking Acts, which formed the backbone of the United States banking system today (Foster 245). Severe financial crisis struck again in 1907, called the Panic of 1907, when alongside a general recession the major banks were allowed to continue operations while being relieved of the aforementioned obligations to redeem their deposits with cash (Rothbard 240). As there was nothing that the United States Treasury could do when a bank demanded cash for shaky bank notes, the result was a move towards a new, centralized bank, an institution that could regulate the economy and serve as a last resort to bail banks out of trouble (Rothbard 240). This followed the four general complaints of most banks and bankers at the time, including the fact that there was no central reserve or central control of the banking system, the dollar circulation was “inelastic”, the Federal treasury was unduly burdened with the redemption of credit monies, and despite their operations, the banks were not liquid. Thus, the creation of the Federal Reserve was born. Signed into law on December 23, 1913, the Federal Reserve Act provided for a regional system of coordinate banks, each working independently in their own territory but bound by together in certain respects by the Federal Reserve Board, now called the Federal Reserve Board of Governors (Foster 280). Federal Reserve banks throughout the country are required to keep a reserve of money, as was one of their purposes in being established; should that money be necessary, it would go to a bank in danger of running out of money (Foster 281). All Federal Reserve banks can also opt to use their money together in one pool, if the Board of Governors agrees that this is the best option (Foster 303). With the law, Congress had established a central banking system, which would enable the most powerful industrial nation in the world at the time to manage its money and credit far more effectively than ever before (Johnson 5). Despite having a centralized banking system, there were still financial crises, most notably the Great Depression in 1929. Faced with an economic boom in the 1920’s, some citizens of the country wanted nothing more than to be left alone, to invest in the stock market. Ignoring the trouble signs on the horizon, most people bought into the United States stock market, investing in large United States corporations (Davidson, and Stoff 686). However, nervous investors in 1929 began selling, and before long, the stock market crashed. Helped along by a weakness in the banking system, the nation soon found itself in a Depression, mainly because when the stock market crashed, borrowers could not repay their loans, and therefore the banks had no money in which to give to depositors when they asked for it (Davidson, and Stoff 709). Again, going back to the original principle, basic functions of a bank are the same no matter what time period in history: they take in money from depositors, and use that money to grant loans to others. Without money on one end of the bargain, there is no money on the other. With the banks in trouble, businesses could not turn to them for money or capital. Businesses cut back on production, firing workers and lowering wages. Soon, the whole country was out of work, a vicious cycle in the United States. Many businesses went bankrupt. Also, in the 1920s, the United States had made large loans to European Nations. When the American banks stopped making loans to other banks overseas, European banks failed as well, and the United States soon found itself in the middle of a worldwide depression (Davidson, and Stoff 710). To restore faith in the banking system, new president Franklin Delano Roosevelt took drastic measures. His first was to declare a “bank holiday” on his second day in office, and have all banks close for a period of eight days. During this time he asked Congress to pass the Emergency Banking Relief Act. Under this act, only banks with enough funds to meet depositors’ demands could reopen, while others had to remain closed (Davidson, and Stoff 715). Roosevelt also passed The Banking Act of 1933, which had three major provisions, including the compulsory separation of commercial and investment banking, the provision of federal “insurance” to guarantee all bank deposits, and prohibiting commercial banks from paying interest on their demand deposits (Rothbard 316). Most of the provisions of the Banking Act of 1933 helped to create a cohesive structure of the banking system, including restoring the faith of the American public by insuring that their deposits would always be backed by the Federal government (Rothbard 317). It also assured the separation of “commercial” banking (those banks that accept deposits from customers) and “investment” banking (those banks that underwrites corporate securities), by severely restricting the buying of securities, except for government securities, as well as prohibiting commercial banks from issuing, underwriting, selling, or distributing any securities, though again, government securities were exempt from these restrictions (Rothbard 317). Investment banks were prohibited from making deposits to customers (Rothbard 317). This did not mean, however, that banks were immune to failure. President Reagan, in the 1980s did away with regulations for savings banks, which resulted in banks making risky or illegal loans (Davidson, and Stoff 828). More often than not, were not paid back, causing the banks to lose their money (Davidson, and Stoff 828). President George Bush felt the impact of this in 1990, when during the late 1980s, hundreds of banks went bankrupt. With so many banks failing, billions of dollars were needed to pay back depositors, and by 1992, Congress had set aside $87 billion dollars to rescue bankrupt or weakened banks (Davidson, and Stoff 828). Currently, the nation is facing one of its greatest crises ever since the Great Depression in the world of banking. Following the theory of bust-follows boom, according to John B. Taylor of the Wall Street Journal, monetary excesses once again brought a bust in 2007. These excesses caused a period of subprime mortgages in lending money for homes, as well as excessive risk taking. Interest rates had been at an all-time low from 2003 to 2005, set by the Federal Reserve, and, according to Taylor as well, actually encouraged the excessive spending and risk-taking. In August 2007, things caught up with everyone and the economy, as well as the monetary structure started to fall apart, as money market account interest rates rose sharply and interest rate spreads jumped to unprecedented levels in just three months (Taylor A19). The cause of the spike was carefully looked at. Was liquidity the problem? Could this be solved by simply opening more windows at the Federal Reserve, and pouring money into the market? Or would it be more worthwhile to look at the balance sheets of the banks, and what kind of loans they had given? (Taylor A19). Frantically, the Federal Reserve lowered the interest rate from 5.25% to 2%, but it did little good. They even tried to create a sub-agency, the Term Auction Facility (TAR), to reduce interest rate spreads and increase the flow of credit, but again, the result was the same: virtually nothing happened. The government tried to stimulate the economy by pouring $100 million dollars into it, but people spent little to nothing of the funds they were given, instead choosing to save it or use it to pay off bills they had accumulated (Taylor A19). As a latch-ditch effort, the Senate Banking Committee introduced TARP, or Troubled Assistance Relief Program, a package of $700 billion dollars to “rescue” big-business banks. Unfortunately, this program contained only a short piece of legislation, no oversight, and little determinations as to how to spend the funds (Taylor A19). A crisis of gargantuan portions was in place, and the country, even today, has yet to see the end of it. Banks continue to flourish in the great nation of the United States, despite the tumultuous happenings and events of history behind them. Even though the country is in the grip of another recession, banks have been bought out by other banks, and while some have closed their doors entirely, the bank on the corner continues to operate. It leaves one to wonder just how much, or how little, banks will change in the future, or if they will be required to change at all. Works Cited Brinkley, Alan. The Unfinished Nation: A Concise History of the American People. 4th. Volume 1. New York: McGraw-Hill Higher Education, 2004. Print. Davidson, James W., and Michael B. Stoff. The American Nation. Upper Saddle River: Prentice Hall, 1998. Print. Foster, Major B. Modern Business: Banking. 16. New York City: Alexander Hamilton Institute, 1918. eBook. . Johnson, Roger T. Historical Beginnings...The Federal Reserve. Rev. ed. Boston: Public and Community Affairs Department, 2010. eBook. . Rothbard, Murray N. A History of Money and Banking in the United States: Colonial Times to World War II. Auburn: Old World Prints, Ltd., 2002. eBook. . Taylor, John B. "How Government Created the Financial Crisis." Wall Street Journal 09 Feb 2009. A19. Web. 20 Sep. 2011. . Read More