Chapter 10

Section 2: The History of American Banking

American Banking Before the Civil War

• During the first part of American history, banks were a very informal business managed by merchants in addition to their regular trade

–Merchants would charge a small fee to keep the money safe or if the customer wanted to take out a loan

–If a merchant went out of businesses or was untrustworthy, customers could lose all of their money

Two views of banking

• After the Revolutionary War, leaders agreed that one of their main goals must be to establish a safe, stable banking system to increase trade & ensuring economic growth of the newly formed United States

• Federalists believed the country needed a strong central government to establish economic and social order.

• Alexander Hamilton was in favor of a national bank which could issue a single currency, handle federal funds, and monitor other banks.

• Anti-federalists were against a strong central government and favored leaving powers in the hands of the states.

• Thomas Jefferson opposed the creation of a national bank, and instead favored banks created and monitored by individual states.

The First Bank of the United States

• 1791- Bank of the U.S. was granted a 21 year charter

• Purposes

–Hold the money the government collected in taxes

–Help the government carry out its powers to tax, borrow money in the public interest & regulate interstate & foreign commerce

• Issue representative money in the form of bank notes, backed by specie

• Ensure that state chartered banks held sufficient gold & silver to exchange for bank notes should the demand arise

• Bank succeeded in bringing order & stability to American banking

• Bank functioned until 1811 when its charter ran out

Chaos in American Banking

• State banks began issuing bank notes that they could not back with specie

• States also chartered many banks without considering whether these banks would be stable & creditworthy

• Financial confusion resulted

• Prices rose rapidly

• Neither merchants nor customers had confidence in the value of the paper money in circulation

• Different banks issued different currency, bankers faced the temptation to print more money than gold to back it

• Merchants had to keep lists of which notes were redeemable by specie & which weren’t

The Second Bank of the U.S.

• 1816- Limited again to a 21 year charter

• Ruled unconstitutional in 1819

• Vetoed for renewal in 1832

The Free Banking Era

• 1837- 1863 known as the Free Banking or “Wildcat” Era

• Between 1830 & 1837 the number of state chartered banks tripled

• Problems

–Bank runs & panics

•Didn’t keep enough specie to back the paper money they issued

• Bank runs- widespread panics in which great numbers of people tried to redeem their paper money at once

• Wildcat Banks

–Located on the edges of settled areas

–Called this because people joked that only wildcats lived there

–High rate of failure

• Fraud

–Bankers issued bank notes, collected gold & silver money from customers who bought the notes & then disappeared

–Anyone who had bought the notes lost their money

• Many different currencies

–State chartered banks were allowed to issue currency

–Notes of the same denominations often had different values

–Many notes were counterfeits

The Later 1800’s

• By 1860, an estimated 8,000 different banks were circulating currency

• To add to the confusions, the government played no role in providing paper currency or regulating reserves of specie

Currency in the North & South

• 1861- U.S. Treasury issued first paper currency since the Continental

–Greenbacks

• South issued currency backed by cotton, hoping that a Confederate victory would ensure the currency’s value

–Notes became worthless as the war went on

Unifying American Banks

• Reforms to restore confidence

–The National Banking Acts of 1863 and 1864 gave the federal government the power to:

1. Charter banks

2. Require banks to hold adequate reserves of silver and gold

3. Issue a single national currency

The Gold Standard

• In 1900, the nation shifted to the gold standard, a monetary system in which paper money and coins are equal to the value of a certain amount of gold.

• Two advantages:

1. It set a definite value on the dollar.

2. The government could only issue currency if it had gold in its treasury to back its notes.

Banking in the Early 20th Century

• Panic of 1907- because the government lacked adequate reserves, many banks had to stop exchanging gold for paper money

–Several banks failed & many people lost their jobs

The Federal Reserve System

• The Federal Reserve Act of 1913 created the Federal Reserve System.

• The Federal Reserve System served as the nation’s first true central bank.

• Reorganized federal banking by:

–Creating 12 regional Federal Reserve Banks throughout the country

• All banks chartered by the national government were required to become members

• Member banks store some of their cash reserves at the Federal Reserve Bank in their district

• All Federal Reserve Banks are supervised by a Federal Reserve Board appointed by the President

• Each regional Federal Reserve Bank allowed member banks to borrow money to meet short terms demands

–Helped prevent bank failures

• Created a national currency

–Allows the Fed to increase & decrease the amount of money in circulation

Banking & the Great Depression

• 1920’s banks loan large sums of money to many high risk businesses, many couldn’t pay back their loans

• Farmers couldn’t pay back loans because of crop failures & hard times

• Stock Market Crash in 1929 resulted in bank runs

Banking Reforms

• Federal Deposit Insurance Corporation (FDIC)

• Insures customer deposits if a bank fails up to $2,500 (today it’s $100,000)

• Currency becomes fiat money, so the Fed could maintain a money supply at adequate levels to support a growing economy

Banking in the Later 20th Century

• As a result from the Depression, banks closely regulated from 1933-1960’s

• Restrictions

–Interest rates banks could pay depositors & rates they could charge for loans

–Banks could only lend money to customers who had a history of paying on time

• By 1970’s banks were eager for reliefs from regulations

–Deregulation led to a crisis in a class of banks known as Savings & Loans (S & Ls)

The Savings & Loan Crisis

• Causes

–Deregulation

•Previously protected & were unprepared for it

–High interest rates

•Had to pay high interest to depositors while receiving low rates on loans

• Bad loans

• Fraud

–Loans to business that had little chance of succeeding

• 1989 Congress passes the Financial Institutions, Reform, Recovery, & Enforcement Act (FIRREA)

–Abolished the independence of the S & L industry & transferred insurance responsibilities to the FDIC

Recent Trends

• 1999, Congress repealed the 1933 Glass-Steagall Act

–Allowed banks to sell stocks & bonds while established new privacy rules for consumer data