U.S. Banking System 1791-1836
The First Bank of the United States was created in February 1791. The U.S. Congress chartered this bank for a period of twenty years to serve as a fiscal agent for the U.S. Treasury. The semi-private, semi-public national bank was a significant factor in the building of the U.S. economy in this period. This bank performed the first central bank functions for the U.S. government and ran from 1791 to 1811, when the U.S. Congress failed to renew its charter. This bank was important because the U.S. government had accumulated a debt to finance the Revolutionary War, and each state of the U.S. had a different currency. The bank was built in Philadelphia when the state was still the capital of the U.S. The bank had eight branches across the nation. It aimed at handling the nation’s war debt and creating a common currency for all the states (Rothbard).
The First Bank played a crucial role in the U.S. banking system because it provoked a nationwide debate over strict interpretation of the U.S. Constitution, as opposed to the common expansive interpretation. In adopting the bank’s proposal and chartering the First bank, the U.S. Congress and the President of the U.S. had to debate bills before taking the necessary steps towards formulating and implementing a fiscal policy that would promote the stability of the new federal government and the continued growth of the U.S.A.
However, there are issues that arose when the First Bank was created. The creation and chartering of the bank was opposed by some members of the Congress because three-quarter of the bank’s ownership was held by foreign investors, and the bank’s operations were carried out through their direct influence. This claim was, however, false because foreign investors were not allowed by the laws governing the bank to elect directors. The opponents also claimed that the First Bank was hiding profits, unconstitutional, operating in a concealed fashion, and a mere money lending tool for the U.S. Government.
The opponents remained strong in opposing the existence of the First Bank since its creation in 1791. By the time the debate was repeated in Congress, the Federalists had lost control of the bank. The First Bank was then headed by the Democrats. The democratic opponents included Vice President George Clinton, Henry Clay, and William Branch Giles. The Federalists were supported by President Madison, who believed the bank’s issues had been settled, and the Treasury Secretary, who believed in the usefulness of the banking institution. This debate led to the demise of the First Bank, and the creation of the Second Bank of the U.S.
The Second Bank of the United States was created in 1816. It received a 20 year charter to serve as the central bank of the U.S. between 1817 and 1836. The bank was a private corporation with public functions. It aimed at handling all fiscal transactions for the U.S. Government. The bank’s dealings and activities were accountable to the U.S treasury and the U.S. Congress. The bank owned the largest stock percentage, while the federal government only owned twenty percent of its stock. The percentage owned by the bank was held by about four thousand private investors that included one thousand foreign investors from Europe.
The major function of the Second Bank was to establish a stable and sound U.S. currency, and to regulate the amount of public credit issued by private banks through the duties performed by the U.S. Treasury. The deposits made by the federal government endowed the bank with its powers to regulate. The bank managed approximately twenty five branches across the nation by 1832.
The demise of the Second Bank can be attributed to President Andrew Jackson. The bank started facing issues in 1832 when President Jackson ordered it to remove all public deposits and disperse them across 91 state banks. When the Congress came up with a bill to sign another charter for the bank after the expiry of the first charter in 1836, President Jackson vetoed the measure, saying that he wanted the Second Bank terminated after its first charter expired. This statement helped President Jackson win the 1832 election against Henry Clay. During the election period, the bank’s president, Nicholas Biddle, and the bank’s supporters, national republicans, heavily clashed with President Jackson’s administration and eastern banking interests, leading to a Bank War. Nicholas Biddle did not support the government’s direct influence over the banking system. Issues such as bribery were used to buy the support of Nicholas Biddle. Surprisingly, the banking system at the time supported the Second Bank as the central bank of the U.S.
In the long run, Biddle’s efforts came to an end and the idea of a central bank lost popularity in the U.S. because of President Jackson’s influence. After its charter expired in 1836, the Second Bank of the U.S. reached its demise. It survived on integrity, ability and prudence, but not the support of the government. The bank was re-chartered under the Pennsylvanian law, but only ran for five more years, until 1841, when it was found to be too over-leveraged. The bank collapsed because of issues such as scandals and heavy debt to European investors.
After the collapse of the central banking system of the U.S. in 1836, the U.S.A faced a period that is referred to as the free banking period. This period existed between 1837 and 1861. Free banking refers to an arrangement in which banks have no special regulatory policies and laws. This means that banks are free to distribute their own money (currencies). In this type of banking system, money markets control the supply of cash. This means that there is no central bank that regulates the supply of money in the markets. Therefore, some institutions are created to act as central banking systems for banks, where banks can get insurance for their currencies, and use them as last resort lenders in case of issues such as liquidation (Grossman).
In this era, the only banks that existed in the U.S. banking system were state-chartered. The banking regulations only allowed the banks to issues bank notes against gold and silver coins, and the state laws regulated the banks interest rates for loans, reserve requirements, the necessary capital ratio, and deposits. In 1837, The Michigan Act was created. It allowed the chartering of banks that met specified requirements without having to get special consent from the legislature of the U.S. The U.S. legislature had reduced the creation of banks that were not stable; consequently, lowering the regulations and supervision that the banks required. This helped strengthen the financial position of the banks (Grossman).
The banks in the era ranging between 1836 and 1861 were very unstable as compared to today’s commercial banks. This is because the average lifespan of the banks in that period was at most 5 years. Approximately half of the banks created and chartered during that period failed, because most banks did not have the ability to redeem their notes. In addition, without a central banking system responsible for common banking laws and a common monetary policy, the money supply and price level of goods and services were more volatile than the money and price levels in the current banking era (Grossman).
During this banking era, some domestic banks were created and took over some of the duties and functions of the central bank. For example, in New York, the New York Safety Fund was created to act as the main deposit insurance institution for the banks that were its members. Moreover, in Massachusetts, Suffolk Bank, Boston, was created to give guarantees to other commercial banks for the value of their currency (notes) in exchange for banking reserves. Another example of an institution that acted as a central bank was the clearinghouse. It was created to act as a lender that banks could run to in case they needed liquidation. The similarity between the banking system in this era and the banking system in the current era is that all banks seek a central banking system as a guarantor for their money and assets (Grossman).
Grossman, Richard S. Unsettled Account: The Evolution of banking in the industrialized world since 1800. Princeton, NJ: Princeton University Press, 2010. Book.
Rothbard, Murray N. A History of Money and Banking in the United States: The Colonial Era to World War II. Auburn, Alabama: Ludwig Von Mises Institute, 2002. Book.