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Understanding The S&L Mess
At its roots lie fundamental tensions that have bedeviled American banking since the nation began
February/March 1991 | Volume 42, Issue 1
Hamilton’s plan, however, aroused intense opposition, led by Thomas Jefferson. Jefferson harbored a fierce, almost visceral hatred of banks, a hatred that grew in direct proportion to a bank’s size. Jefferson transmitted this passion to his political heirs. Laws designed to keep banks small, if not nonexistent, proliferated.
Many states, for instance, limited or forbade branching. A feature of the American economy ever since, this has had no small consequences by forcing the creation of thousands of independent or so-called unit banks. Even today, with only about 40 percent as many banks as in the early 1920s, the United States still has at least ten times as many banks as all the other industrialized countries put together. Great Britain gets along with just thirteen commercial banks.
The number of American banks expanded steadily under Hamilton’s system. When the Bank of the United States was established in 1791, there were only three other banks in the country. Twenty years later there were nearly two hundred and fifty. While Hamilton’s national bank effectively influenced other banks with its power to refuse particular bank notes in payment of federal taxes, it was each state that chartered, regulated, and audited all the other banks, with widely varying degrees of zeal and competence.
Missouri and Indiana, for instance, each had a single, state-owned, many-branched central bank, a system that worked well. Louisiana had a system of closely regulated commercial banks and a national reputation for sound banking. Illinois and Michigan, on the other hand, had banking systems notorious for flimflam, fraud, and failure.
At first every bank charter required a special act of legislation, and politics played a large part in who obtained charters and who did not. Aaron Burr, for instance, had to sneak a clause into a charter for what was supposed to be a water company in order to found what would in time become the Chase Manhattan Bank.
In 1837 the principle of free banking was established, first in Michigan and the following year in New York State, and it quickly spread. Under free banking a new bank had only to fulfill basic requirements set by the law in order to enter the banking business. Personal politics was driven out of banking by the new system, but interest-group politics certainly was not. Because there have always been so many banks in this country, the banking industry has been a strong, often too strong, voice in the political process.
In 1857 it was noted that American “banks never originate with those who have money to lend, but with those who wish to borrow.”
Hamilton’s bank lost its struggle to have its national charter renewed in 1811 and became an ordinary state bank, chartered by New York. Although a second national bank was established in 1816, it never exercised the control the first one had had over the rapidly expanding American banking system. Andrew Jackson killed the second bank in 1836, and for three-quarters of a century thereafter the United States was the only major country with no central bank.
In the years after Jackson, therefore, the nation’s money supply was determined entirely by a Hydra-headed system of hundreds of independent banks, regulated both well and badly by more and more state governments as the Union expanded. A steady tattoo of local bank failures, punctuated by occasional national financial panics, was the inevitable result.
With discipline much loosened by the decline and fall of central banking in the United States, banks, and bad banking, proliferated. By 1840 there were a thousand banks in operation in the United States; twenty years later the number had nearly doubled. But almost half the banks founded between 1810 and 1820 failed before 1825. A similar percentage of those founded in the 1830s failed before 1845.
Although the first English banks were born because people had money to lend, America’s completely undeveloped economy reversed the impetus to bank formation. As early as 1857 one observer noted that “it has become proverbial that banks never originate with those who have money to lend, but with those who wish to borrow.” This was true even as early as Aaron Burr’s day. Three years after Burr founded his bank, he owed it $64,903.63, a fortune.
Part of the rapid spread of banks was due to the fact that the new United States was growing with enormous speed, and swift economic growth is always a messy business. In the seventy-three years between the adoption of the Constitution and the outbreak of the Civil War, the nation’s territory tripled and its population increased eightfold. The economic output of the country (today we would call it the GNP) multiplied eighteen times and its money supply no less than forty times, from $15 million to $600 million. Only 25 percent of this money supply, however, was in the form of gold and silver. The rest was in deposits and bank notes.