The Reluctant Central Bankers: Clearing House Loan Certificates in the National Banking Era

Jon Moen The University of Mississippi,

Ellis Tallman Oberlin College

First Draft. Please do not cite or quote without permission from the authors.

February 2012 The big New York banks were in a position to serve as a private lender of last resort for the United States during the National Banking Era. As a lender of last resort the big New York banks could aid illiquid banks by increasing the volume of reserves available to the banking system. But that they had the incentives to behave so is less clear, for the interests of these private bankers were not necessarily aligned with the collective banking interests in New York, much less in the rest of the nation for that matter.

The historical record reveals that the large New York banks indeed behaved in ways that approached those of a central bank, as in the Panics of 1873, 1884, and 1890.

On other occasions, however, they missed the mark. Intermediaries that were not members of the Clearing House were not likely to be aided in a timely way, nor were banks far removed from New York City likely candidates for assistance, as in 1893. The

Panic of 1907 seems to be an instance in which the Big Six hesitatingly provided central bank services to a constituency broader than the Clearing House banks only after the dangers to the big banks had become clear. In general, the New York banks still had to put their own, private reserves at risk during a panic, making them reluctant to help non-

Clearing House interests unless their own interest was also threatened.

I. History and Central Bank-like Tools

Bank reserves had become increasingly concentrated in New York City, as interior banks sent cash to New York to meet reserve requirements established by the

National Bank Acts. The big New York national banks sat at the top of this pyramid of

2 reserves, and their ability to mobilize reserves combined with the supervisory capabilities of their New York Clearing House left them with nascent central bank powers. The sudden desire of out of town correspondent banks to liquidate their deposits in New York was a main source of panics, at least in New York.

The New York Clearing House developed several tools that allowed the banks to deal with panics and runs on deposits. One of them, clearing house loan certificates, was particularly central bank-like. Clearing house loan certificates were IOUs backed by collateral and used by banks in place of cash to settle accounts between banks during the check clearing process at the Clearing House.1 During a panic the use of Clearing House loan certificates freed up cash to pay out to depositors, buy up loans, and facilitate gold imports. In some ways they resembled discount window loans at the Federal Reserve, although a Clearing House Committee had to be assembled to formally authorize and over see their issue, while the discount window is always available.

Suspension of convertibility of deposits into cash was a drastic tool used in panics. Suspension usually occurred near the time loan certificates were authorized.

Contemporary observers like O.M.W. Sprague criticized suspension as an unnecessary response, one that usually added to panic. On the other hand, Friedman and Schwartz regarded suspension as a reasonable response to a panic. One side effect of suspension was often to raise a premium on currency over deposits. The premium would induce gold inflows, adding to the circulating medium and often being used to pay off panicked correspondent banks in the interior.

Another tool, reserve pooling, had been abandoned after successfully being used in the Panic of 1873 according to Elmus Wicker (2000). With a pooling arrangement, the

1 Timberlake, Gorton, Tallman and Moen.

3 Clearing House Committee was also authorized to equalize legal tender reserves when clearinghouse loan certificates were authorized.2 In effect, the reserves of the member banks were united into one pool that the members could issue loan certificates against. In cases where a bank was falling dangerously low in actual reserves, the other members could be assessed and reserves would be directly provided to the troubled bank from the pool. The Clearing House also suppressed publication of reserve positions and loan certificate issues of individual banks, reporting only aggregates to the public through the

Commercial and Financial Chronicle, for example.

The tools available to the Clearing House banks were used quite differently during the major panics of the National Banking Era. The Panic of 1873 hit the financial markets of New York after the failure of several of several private banks in New York, the most spectacular of which was Jay Cooke and Co. on September 18. The Clearing

House authorized loan certificates and gave the Clearing House the authority to equalize reserves across member banks on September 20.

The New York banks responded quite differently to the Panic of 1893, mainly because it started in the interior of the country. The Clearing House issued loan certificates on June 15 in response to bank panics in several interior cities, but there was no crisis in New York. After a delay, New York banks restricted payments to interior banks on August 3 because they did not want to suffer further reserve losses. They also declined to pool reserves.

The Panic of 1907 hit squarely in the middle of the New York money market, focusing on the trust companies and threatening to take down the banks with them. The runs on deposits at the trusts began on Tuesday, October 22 after the national Bank of

2 Commercial and Financial Chronicle, Sept. 27, pp. 410-11.

4 Commerce refused to continue clearing for the Knickerbocker Trust Company. After several attempts by J.P. Morgan and friends to pool private funds to aid trust companies and the stock market, the Clearing House authorized the use of loan certificates and suspension of payments on Saturday, October 26 to take effect on the 28th. It did not authorize reserve pooling among member banks.

II. The Reactions by the Big Banks in 1873, 1884, 1890, 1893, and 1907: Clearing House Loan Certificates

We focus on the use of clearing house loan certificates by the big New York banks during panics, as they most resemble the tool of a central bank intent on increasing reserves during a crisis. The New York Clearing House banks used clearinghouse loan certificates in all of the major banking panics during the national banking era. But the big banks reacted to the authorization quite differently depending on the origins and location of the panic. If the panic was centered in New York City and their interest was immediately threatened, as it was in 1873, the big banks appear to have been much more willing to issue loan certificates than if the panic was centered elsewhere in the country, as in 1893. In 1907 the Clearing House hesitated to authorize the issuance of loan certificates because the panic initially was centered on trust companies, which were not members of the Clearing House. In all panics the Big Banks use of loan certificates varied substantially across banks, indicating that responses similar to that of a central bank were not at all assured.

Our analysis of clearing house loan certificates uses a new data set drawn from the minutes of the New York Clearing House Loan Committees from the 1873, 1884,

1890, 1893, and 1907 panics. In response to depositor runs during the major panics, the

5 New York Clearing House would appoint a subcommittee of bank officers to oversee the issuance of loan certificates during the panic. The minutes of the committee compiled by the Clearing House contains, among other valuable records, the volume of loan certificates issued and withdrawn by each New York national bank in 1873, 1884, 1890,

1893 and 19073. We have entered this information into a computer readable form.

Previous studies have had to rely on the aggregate volume of certificates issued during a panic. Thus, we are able to identify which banks were most involved in the loan certificate market and how quickly they reacted to the onset of a panic. We supplement the loan certificate data with balance sheet information by bank taken from the Annual

Reports of the Comptroller of the Currency of the United States for the national banks and from the New York Superintendent of Banks for the state banks that were Clearing

House members.4 The information from the Comptroller will allow us to identify characteristics of banks that would make them more likely to issue loan certificates. A bank’s connection to the correspondent banking system, for example, as measured by the volume of deposits due to other banks, might be an important correlate with the volume of loan certificates issued by a bank.

A. The Larger Panics: 1873, 1893 and 1907

Making comparisons across specific banks from 1873 to 1907 is complicated by the fact that the big banks in 1873 weren’t the same ones in 1907. For example, the First

National was rather small in 1873; by 1907 it was the fourth largest. National City Bank,

3 These figures include the certificates issued by some state chartered banks that cleared through the Clearing House. While the membership was dominated by national banks, it was not restricted to national banks nor were national banks required to be members of the Clearing House, as they were of the Federal Reserve System. 4 We use the call report date that is closest to the start of each panic.

6 James Stillman’s bank in 1907, was only the seventeenth largest in 1873; it was largest in

1907. We examine the behavior of the six largest banks in each panic based on the volume of assets. The choice of six is somewhat arbitrary and follows Sprague’s decision to focus the six largest banks in the panic of 1907.5 Nevertheless, how the mix of banks that issued loan certificates in panics changed reveals much about the ability of the larger banks to coordinate lender of last resort functions. We focus first on the largest panics--1873, 1893, and 1907—as each was unique in how New York was affected and how the Clearing House Banks reacted. We return to 1884 and 1890 as two examples, following Sprague (1910) and Wicker (2000), as examples of how the Clearing House banks handled panics when their local interests were immediately threatened.

Furthermore, we look only at the mix of banks, defined by volume of assets and loan certificates issued, participating the in issuing loan certificates. Balance sheet characteristics will be examined in a separate paper.

1. The Panic of 1873

The Panic of 1873 was much like the Panic of 1907 in that both were centered in

New York, unlike 1893. It started with the failure of Jay Cooke and Company, a well- regarded merchant bank in New York. Cooke was over-exposed to several investments in railroad bonds, most notably the Northern Pacific. A stock market panic soon followed. The New York Clearing House Committee authorized issuing clearing house loan certificates on September 20 and partially suspended payments on September 24.

5 In 1907 the Big Six were National City Bank, National Bank of Commerce, Hanover National Bank, National Park Bank, First National Bank, and Chase National Bank (Sprague 1910, p. 267). This is the traditional definition of the Big Six. In 1873 the six largest banks were the Fourth National Bank, the National Bank of Commerce, National Park Bank, the Bank of New York, the Metropolitan National Bank, and the Importers and Traders National Bank.

7 Wicker points out that the New York Banks continued to pay legal tender currency6 to their correspondents even in the presence of suspension.

The responses of New York banks to the authorization of the use of loan certificates were not uniform. While the larger banks tended to issue loan certificates, there were notable exceptions. And unlike in 1907, the state chartered banks were more involved, issuing close to 18 percent of all loan certificates in New York. In short, it appears that in 1873 the big national banks weren’t fighting the panic alone: they had help from other intermediaries.

Tables 1 and 2 present the volume and percentages of loan certificates issued by banks in 1873. Table 1 presents only national banks ranked by volume of assets, while

Table 2 ranks all banks by volume of loan certificates issued. Both state and national banks were Clearing House members and issued loan certificates. It is notable that of the national banks listed in Table 1, several of the largest do not issue loan certificates, the

National Bank of Commerce and the American Exchange National Bank; Importers and

Traders issued only 500,000. Of all banks issuing loan certificates in 1873, the Bank of

North America is ranked fourth, and it was a state-chartered bank. It had switched its charter and was a national bank by 1893. The banks listed in table 2 reveal that the banks other than the largest national banks were willing to issue large volumes of loan certificates.

Table 1: Volume of Loan Certificates, New York national banks ranked by volume of assets.

6 Gold coin did not circulate and currency did not become convertible to gold until 1879, although specie could be used as reserves by banks.

8 Bank 1873 Percent Fourth National 4,880,000 19 National Bank of 0 0 Commerce National Park Bank 3,370,000 13 Bank of New York 1,300,000 5 Metropolitan National 1,500,000 6 Importers and Traders 500,000 2 National Bank Total, Other NY National 13,735,000 55 Banks Total, All NY Banks 25,285,000 Source: Minutes of the New York Clearinghouse, September 20 and on, 1873.

Table 2: Volume of Loan Certificates, all New York banks ranked by volume of loan certificates issued.

Bank 1873 Percent Fourth National 4,880,000 19 National Park Bank 3,370,000 13 Central National Bank 2,375,000 9 Bank of North America 2,080,000 8 (state bank) Metropolitan National 1,500,000 6 Bank of New York 1,300,000 5 Total, Other NY Banks 9,780,000 40 Total, All NY Banks 25,285,000 Source: Minutes of the New York Clearinghouse, September 20 and on, 1873.

The big New York national banks thus had support from other banks in 1873, like

Central National, Ninth National, and the Bank of North America. This reveals that the

largest New York national banks did not have to place the bulk of their reserves at risk in

9 The panic of 1893 started in the interior of the country and did not threaten the

New York banks directly. The lack of an imminent threat is revealed in Table 3, which

shows that the six largest banks issued only 27 percent of the loan certificates. The

largest issuers of loan certificates issued 42 percent. The New York banks issued a larger

volume of loan certificates than in 1873 (1884 and 1890), but it was spread out over time

during a period before the crop-moving season really took hold, a time of seasonal money

market tightness.

Table 3: Volume of Loan Certificates, New York national banks ranked by volume of assets, 1893.

Bank 1893 Percent National City Bank 3,480,000 9 Chemical National Bank 0 0 First National Bank 4,000,000 10 Fourth National Bank 1,585,000 4 Importers and Traders 0 0 National Bank of 2,000,000 5 Commerce Total, Other NY Banks 30,410,000 73 Total, All NY Banks 41,475,00 Source: Minutes of the New York Clearinghouse, June 15 and on, 1893.

10 Table 4: Volume of Loan Certificates, all New York banks ranked by volume of loan certificates issued, 1893.

Bank 1893 Percent First National Bank 4,000,000 10 National Park Bank 3,480,000 9 American Exchange 3,000,000 8 Mercantile National Bank 2,805,000 7 Chase National Bank 2,000,000 5 National Bank of 2,000,000 5 Commerce Total, Other NY Banks 24,190,000 58 Total, All NY Banks 41,475,000 Source: Minutes of the New York Clearinghouse, June 15 and on, 1893.

The Panic of 1907, while centered on the trust companies, still presented a grave

threat to the national banks if it were not contained. If the call loan market had frozen up

and the stock market collapsed, the Clearing House banks would have been dragged

down with the trust companies. Five of the “Big Six” banks participated heavily, issuing

more loan certificates, collectively and individually, than they had in earlier panics. The

curious exception is Hanover National. The five banks that did issue loan certificates

were also the top five in terms of volume of loan certificates issued, having been joined

by Mechanic and Traders State Bank. Mechanics and traders came into the panic with a

large volume of certificates outstanding. It had been part of the run focused on the banks

associated with Heinze-Morse-Thomas chain of banks in the week before the run on the

trust companies started. The Clearing House had successfully stamped out the run on

these banks.

11 Table 5: Volume of Loan Certificates, New York national banks ranked by volume of assets, 1907. ”The Big Six.”

Bank 1907 Percent National City Bank 17,000,000 17 National Bank of 5,750,000 6 Commerce First National Bank 10,000,000 10 National Park Bank 9,700,000 5 Hanover National Bank 0 0 Chase National Bank 10,500,000 10 Total, Other NY Banks 47,960,000 50 Total, All NY Banks 100,910,000 Source: Minutes of the New York Clearinghouse, October 26 and on, 1907.

Table 6: Volume of Loan Certificates, all New York banks ranked by volume of loan certificates issued.

Bank 1907 Percent National City Bank 17,000,000 17 Chase National Bank 10,500,000 10 First National Bank 10,000,000 10 National Park Bank 9,700,000 10 National Bank of 5,750,000 6 Commerce Mechanics and Traders 4,485,000 4 State Bank Total, Other NY Banks 43,475,000 43

12 Total, All NY Banks 100,910,000 Source: Minutes of the New York Clearinghouse, October 26 and on, 1907.

4. 1893 and 1907: the Big Six Compared

We next compare the behavior of the Big Six banks as ranked in 1907 in the panics of 1893 and 1907. In both panics most of the same New York banks were key in combatting the panic, but the sources of the panics were quite different. The Panic of

1907 was clearly centered in New York City, while the Panic of 1893 was a panic that took place in the interior of the country. Table 7 presents the volume of loan certificates issued by the Big Six banks and all other banks in New York in the Panics of 1893 and

1907. The behavior of the Big Six banks changed substantially between 1893 and 1907.

In 1893 they issued 28 percent of loan certificates, while in 1907 they issued 53 percent of all loan certificates authorized by the Clearing House. Their issuance increased 362 percent from 1893 to 1907, while all remaining New York banks increased 60 percent.

Several of the Big Six increased their issuance of loan certificates dramatically. Most noticeable was National City Bank, which issued no certificates in 1893 but issued $17 million worth in 1907. James Cannon (1910) notes that this amount alone was greater than that issued by any other clearinghouse, except for Chicago. It also is as much as the increase from the other New York national banks between 1893 and 1907. A few of the smaller banks increased the volume of certificates they issued. For example, Mechanic’s and Trader’s National Bank issued $3.9 million more in 1907 than in 1893. Many of the smaller banks, however, issued fewer certificates in 1907 than in 1893. Hanover

National Bank is odd in that it issued no certificates in either crisis, nor did it in 1890.

We do not know why Hanover was absent in the loan certificate. A Hanover runner presented $1.5 million in checks to Knickerbocker Trust at the outset of the Panic of

13 1907, causing its immediate closure. Perhaps Hanover chose to increase its liquidity through channels other than with loan certificates.

Table 7: Total Volume of Loan Certificates Issued by NYC Banks, 1893 and 1907

Bank 1893 1907 Percent Change National City Bank 17,000,000 Infinite

0 National Bank of 2,000,000 5,900,000 95 Commerce Hanover National Bank 0

0 0 National Park Bank 3,480,000 9,700,000 179 First National Bank 4,000,000 10,000,000 150 Chase National Bank 2,000,000 10,500,000 425 Total, Big Six NY Banks 11,480,000 53,100,000 362 Total, Other NY National 30,010,000 47,960,000 60 Banks Total, All NY Banks 41,490,000 101,060,000 144 Source: Minutes of the New York Clearinghouse, October 26, 1907.

Because the Panic of 1907 was centered on New York, unlike 1893, the big New

York banks had a greater incentive to issue loan certificates to protect their own interests than they had had in 1893. The panic in 1893 started in the interior and west of the country, with runs on banks in cities like Chicago, Omaha, Milwaukee, Los Angeles, San

Diego, and Spokane. According to Wicker (2000, p. 63) the runs on deposits in Chicago,

Omaha, Detroit, Cleveland, and Kansas City was concentrated solely among the savings

14 banks, where checking was not widespread and individual deposits were small. Thus, in

1907 the private interest of the big New York banks and the collective interest were probably much closer together than in 1893.

How do contemporary and modern observers of the banks evaluate the response of the banks in these two crises? O.M.W. Sprague is perhaps the most famous observer of the panic. He criticized the New York banks for delaying in issuing Clearing House loan certificates until Friday, October 26, four days after the run on the Knickerbocker

Trust and then the Trust Company of America had started. Had they been issued immediately, Sprague also points out that the banks could have avoided the unfortunate step of suspending cash payments, which occurred almost immediately after loan certificates were issued. James G. Cannon was less pessimistic than Sprague about the delay in issuing loan certificates, and he notes the concern among Clearing House members over issuing loan certificates (Cannon 1910, pp. 117-18). Indeed, J.P. Morgan was reluctant to authorize the issuance of loan certificates early in the panic, fearing that depositors would interpret the issuance as a sign of weakness among the banks (Wicker

2000, p. 94). Cannon’s somewhat favorable diagnosis should be taken with some caution, as he also served as Chairman of the New York Clearing House Sub-Committee overseeing the issuance of loan certificates in 1907.

5. 1884 and 1890

Wicker views the Panics of 1884 and 1890 as real success stories on the part of the Clearing House. Its prompt action prevented full-scale panics from erupting out of financial disturbances in New York. In 1884 the largest banks issued only 26 percent of

15 loan certificates, leaving the task to other banks (Table 8). Much of the incipient panic was focused on Mercantile National Bank, which was rumored to have been caught in a large amount of fraudulent speculation in railroad stocks, rumors that were not confirmed by the Comptroller. It issued 33 of all loan certificates issued in 1884, but it had much help from other banks. Six banks accounted for 89 percent of all loan certificates issued

(Table 9).

Bank 1884 Percent National City Bank 3,000,000 13 Importers and Traders 0 0 National Park 3,000,000 13 National Bank of 0 0 Commerce American Exchange 0 0 Chemical Bank 0 0 Total, Other NY Banks 16,585,000 74 Total, All NY Banks 22,585,000 Source: Minutes of the New York Clearinghouse, May 14 and on, 1884.

Table 9: Volume of Loan Certificates, all New York banks ranked by volume of loan certificates issued, 1884.

Bank 1884 Percent Metropolitan 7,450,000 33 Bank of New York 4,000,000 18 Fourth National 3,000,000 13 National Park 3,000,000 13 Hanover 1,650,000 7

16 Mercantile National 1,030,000 5 Total, Other NY Banks 2,455,000 11 Total, All NY Banks 22,585,000 Source: Minutes of the New York Clearinghouse, May 14 and on, 1884.

The pattern of loan certificates issued in 1890 indicates that the largest national banks did not participate heavily in issuing loan certificates; only two of the six issued any certificates at all (Table 10). Several state banks also participated, unlike in 1884.

Bank 1890 Percent Fourth National 0 0 Chemical 0 0 National Bank of 1,000,000 6 Commerce Importers and Traders 0 0 American Exchange 2,400,000 15 National Park 0 0 Total, Other NY Banks 12,715,000 79 Total, All NY Banks 16,115,000 Source: Minutes of the New York Clearinghouse, November 11 and on, 1890.

17 Table 11: Volume of Loan Certificates, all New York banks ranked by volume of loan certificates issued, 1890.

Bank 1890 Percent Bank of New York 2,880,000 18 American Exchange 2,400,000 15 Bank of North America 1,450,000 9 (state bank) Mechanics and Traders 1,090,000 7 (state bank) Chatham National 1,000,000 6 National Bank of 1,000,000 6 Commerce Total, Other NY Banks 6,295,000 39 Total, All NY Banks 16,115,000 Source: Minutes of the New York Clearinghouse, November 11 and on, 1890.

CONCLUSIONS

While the big Clearinghouse banks in New York City had nascent central bank powers, they were not consistently used in the way a central bank promoting the general welfare of the banking system would have. In 1893 the big six banks issued a small percentage of loan certificates, leaving the task to other smaller banks because the large banks had little interest in aiding troubled interior banks. The Panic of 1907 was different, threatening the big banks directly. While they issued a much larger percentage of loan certificates and acted more like a central bank, their actions were only sufficient to contain the panic until gold imports arrived in sufficient volume to arrest the panic.

Because the 1907 panic was centered in New York City on the trust companies and not the Clearing House banks, reluctance in issuing loan certificates to aid non-members is understandable. In Chicago the trusts were members of the Clearing House. While the actions of the Big Six national banks certainly helped to stem the panic, the bankers realized that their willingness or ability to deal with future, more severe panics was questionable.

18 Relying on aggregated measures of clearing house loan certificates alone suggests a united approach among Clearing House banks to fight panics during the National

Banking Era. We show that there was great variation in the responses of individual New

York banks to each panic, and there appears to have been little pre-conceived effort in providing liquidity to the banking system. By pre-conceived we mean banks participating in some pre-determined proportion of their assets or deposits, for example.

Some large banks participated substantially, other large banks not at all. And the degree of participation by each bank varied from panic to panic. The decisions to extend credit to nonmember institutions or merely to address the panic conditions affecting those institutions were effectively made on the fly and likely were related to characteristics unique to each bank.

REFERENCES

Cannon, James G. (1910b). Clearing Houses. Publications of the National Monetary Commission, Volume 6 (Washington, DC: Government Printing Office).

Gorton, Gary (1985) “Clearing Houses and the Origins of Central Banking in the United States.” Journal of Economic History 45, 2, 277-84.

Sprague, O.M.W. (1910), History of Crises under the National Banking Era, National Monetary Commission (Washington: Government Printing Office).

Tallman, Ellis and Jon Moen. “Liquidity Creation without a Central Bank: Clearing House Loan Certificates in the Banking Panic of 1907,” forthcoming, Journal of Financial Stability.

19 Timberlake, Richard H. (1993) Monetary Policy in the United States: An Intellectual and Institutional History. Chicago: University of Chicago Press.

Wicker, Elmus. (2000) Banking Panics of the Gilded Age, New York: Cambridge University Press.