Outline of Banking History From the First Bank of the Through the By B. H. BECKHART Columbia University United States was particularly The entire capital was subscribed THEfortunate in having as its first within two hours on the day the sub- Secretary of the Treasury a veritable scription books were thrown open, and genius, whose program of fiscal reform the Bank was ready to begin business quickly placed the new republic on a on December 12, 1791, with Thomas sound financial basis. As an essential Willing as president.6 From the very part of his program, Hamilton urged outset, the Bank proved to be a great the establishment of a success, in providing the country with in a report to Congress, dated Decem- a sound and elastic currency, in supply- ber 1~,1~’90. Since the economic signif- ing the needed banking facilities, and icance of banks was then but crudely in preventing any excess issue of state understood, Hamilton, in this now fa- bank notes by having such state notes mous document, first indicated the as were in its possession redeemed. In numerous advantages resulting from the performance of its fiscal functions, banking in general and from a National it transferred government funds and Bank in particular, taking occasion to provided a safe depositary for them; it dispel some of the current erroneous also helped to collect the revenues and ideas on the subject.’ After showing provided the bullion needed by the that no one of the three banking insti- mint in coinage. Further, by 1795 it tutions2 then in existence could be suit- had loaned the government $6,200,000. ably employed as a National Bank, In order to procure funds to repay the he laid down in great detail the plan loan, the government by 1802 had sold for the new institution.3 The act all of its stock at a profit of $671,860, chartering the bank modelled upon this and while a shareholder had received plan was signed by the President on $1,101,720 in dividends of 8§ per cent. February 25, 1791.44 On April 20, 1808, the stockhold- ers memorialized for a re- 1 Hamilton’s report may be found printed in Congress full in the American State Papers—Finance I., newal of the charter which expired in pp. 67-76. 1811. A month later, Albert Gallatin, 2 The founded in then Secretary of the Treasury, in a 1781, the Bank of Massachusetts in 1784, and to enumerated the the Bank of New York in 1784. report Congress fiscal services of the and advised 3 Hamilton’s plan closely followed the charter Bank of the as it existed at that time. that the charter be renewed with a few 4 The act provided for a capital of $10,000,000, changes. Nevertheless, the bill to con- of which one-fifth was to be subscribed by the tinue the charter was defeated, the government. The administration was placed in the hands of twenty-five directors elected an- oftener than once a week by the Treasury nually by the shareholders. Branches were to Department. be established where the directors saw fit. The 5 July 4th, 1791, at . circulation was not to exceed the capital. State- 6 Formerly, president of the Bank of North ments of condition might be called for but not America. 1

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opponents charging that the Bank was to 1817. Further, without the assist- a &dquo; money trust&dquo; controlled by foreign- ance of the Bank, the government had ers,7 a tool in the hands of the Federal- difficulty in selling its bonds (even ists, and that the act chartering the when offered below par), and was bank was unconstitutional-so the forced to borrow sums from the state First United States Bank went out of banks and to issue some 37 million existence on March 3, 1811.8 dollars of &dquo;Treasury notes&dquo; which &dquo;ultimately degenerated into a kind of FINANCIAL CHAOS, 1811-1816 currency.&dquo;&dquo; Writing in 1831, Gallatin stated that had the Bank been rechar- It was a most unfortunate time for tered, the have been the country, on the verge of a war with suspension might and the state banks would England, to be deprived of the services prevented have been restrained within of the Bank. State banks on proper sprang up bounds. every hand to take its place. Their number increased from 88 in 1811 to THE SECOND BANK OF THE UNITED 24s in 1816 and their circulation grew STATES from ~~.’~ million dollars in 1811 to 100 As early as October 14, 1814, Secre- millions six years later.9 Such a rapid Dallas,12 in a report submitted to of the currency resulted nat- tary called attention to the need urally in the depreciation of bank notes Congress, for a National Bank, the in terms of gold, amounting at the emphasizing fact that such a bank could restore the maximum to 23 per cent in Baltimore, currency to a gold parity and 16 per cent in Philadelphia and depreciated New York.lo and that in its fiscal relations with the would be of incalculable The revenues of the government, Treasury assistance. After seven unsuccessful consisting largely of tari~ were duties, within two the charter for the most part collected in this attempts years, of the Second Bank, closely resembling depreciated currency, while it was that of the was Con- necessary for the nation to make First, passed by large and became law on disbursements of funds in New gress April 10, Eng- 1816.13 an with land where specie payments had been Through agreement maintained. reason of con- 11 By this Willis, H. P., American Banking.1918, p. 209. dition, it has been estimated that the 12 Alexander J. Dallas from Pennsylvania, government lost $5,000,000 from 1814 appointed Secretary of the Treasury, October 6, 1812. 7 Though three-fourths of the stock was held 13 The act provided for a capital of $35,000,000, abroad, the foreign shareholders exerted little of which the government subscribed one-fifth. control, as they were not allowed to vote through There were to be twenty-five directors, twenty of proxies. whom were to be elected annually by the share- 8 By 1834 the process of liquidating the assets holders and five appointed by the government. had been completed, the shareholders receiving Branches were to be established wherever the in all $434 for each $400 share. The assets of Bank thought necessary, managed by from seven the parent bank in Philadelphia were purchased to thirteen directors appointed by the parent by Stephen A. Girard, which was reopened on bank. The circulation was not to exceed the May 12, 1812, as "Girard’s Bank." capital. Deposits of public funds were to be 9 This increase was due to two factors: (1) made in the Bank unless the Secretary of the the suspension of specie payments everywhere Treasury should otherwise direct. The Bank during August of 1814 excepting in New Eng- was required to pay the government a bonus of land; and (2) to the withdrawal of the restraining $1,500,000 and to transfer public funds without influence of the Bank. charge. Weekly statements of condition might 10 The specie was either driven abroad or into be called for and Congress was given the right to the New England States. inspect the books of the Bank.

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 3 the state banks in the larger towns, the bursing government funds, in furnish- resumption of specie payments was ing domestic exchange, in paying the brought about (nominally at least) by pensioners of the government, and in February 20, 1817, thus realizing the acting until 1833 as the sole depositary first purpose of the Bank. Due partly of public moneys, the Bank was of great to governmental pressure and partly to service to the whole people. a lack of banking training, the direc- In his first message to Congress, on tors, at first, extended loans and rapidly December 8, 1829, President Jackson increased the circulation, a policy expressed doubts as to the constitu- which resulted in a heavy loss to the tionality of the Bank and the sound- Bank and in the retirement of William ness of its notes. The President’s Jones as president in January of 1819. hostility subsequently cooled, but Langdon Cheves, chosen as his succes- when the Whig party at Baltimore in sor, immediately inaugurated a policy 1831 took the side of the Bank, there of retrenchment and deflation. Under ensued a long and bitter struggle which his management and later under that ended in the defeat of the attempt to of Nicholas Biddle, the Bank became recharter it. The reasons as given by &dquo;the most powerful and best managed Professor Catterall for this opposition financial institution the country had were the &dquo; widespread belief that the ever seen.&dquo; ~4 Its notes, circulating from Bank was unconstitutional, the hostil- Montreal to Mexico City, were safe ity of the states, the opposition of the and elastic, In transferring and dis- state banks, the rise of democracy,

14 Willis, H. P., American Banking. 1918, p. 210.

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and the envy and hatred which the and the government, whereby they poor always feel for the rich.&dquo;15 were required to give security for the Upon the failure to recharter the funds deposited &dquo; whenever the deposits Second Bank, the era of central banks, should exceed one-half the bank modelled after those existing in Europe, capital paid in,&dquo; 17 or whenever the passed. Banking in America entered government deemed it necessary. The upon entirely different lines of devel- banks agreed to perform for the govern- opment. In the years that followed, ment all of the fiscal services formerly the government was to miss keenly rendered by the Bank of the United the fiscal services of the Bank, and States, to render weekly reports, and the people, no longer protected by to submit to examinations when the its restraining influence on the note Secretary thought necessary. On June issues of the state banks, suffered 23, 1836, an act was passed &dquo;to regu- severely from the resulting financial late the deposites of the public money&dquo; chaos. following closely the provisions of Taney’s contracts.18 In his annual THE INDEPENDENT TREASURY message, September, 1837, Van Buren From 1791 to 1811, the First Bank showed that the custody of the public was utilized to a large extent as a funds by state banks had proved very depositary of government funds. After unsatisfactory and urged that the its charter had expired the government government take care of its funds itself was forced to use the services of state and require that all dues be paid in banks, from whom no security was specie. While this suggestion was required for the moneys deposited, but being considered, the public funds were by whom in accordance with an agree- left in the hands of the collecting offi- ment entered into, weekly and monthly cers and a few banks. statements of condition were to be The bill creating the Independent submitted to the Secretary of the Treasury, finally passed on July 4, Treasury. The use of state banks as 1840, was repealed on August 13, depositaries proved so unsuccessful 1841, and was repassed on August 6, that it was provided, in the charter of the Second Bank, that it was to be the 17 Kinley, David, Independent Treasury. 1910, sole depositary except in such places pp. 26, 27. 18 This act provided that the banks selected as where the Bank had no branches, or depositaries must furnish the Secretary with a when the Secretary of the Treasury statement of their condition, a list of their direc- deemed it unwise to employ it as such. tors, the current price of their stock and a copy This latter provision of the act was of their charter. Further, the Secretary might taken advantage of in September of examine the general accounts. Such banks must redeem their notes upon demand, and no bank 1833 who &dquo;or- by Secretary Taney, issuing notes of a denomination of less than $5 dered the collectors of revenue to cease was to be chosen. Collateral against the funds depositing in the Bank of the United so deposited could be called for whenever the States and to Secretary deemed this necessary, and must be employ designated called for if the state banks for that deposits exceeded one-half purpose.&dquo; 16 the Bank’s capital. In return for such deposits, A contract was entered into between the banks must render the government all the these banks (the so-called &dquo;&dquo;) services and duties heretofore required of the Second Bank. It was further provided that if 15 Catterall, Ralph C. H., The Second Bank of the government’s deposits exceeded a fourth the United States, p. 164. part of the Bank’s capital for at least three 16 Kinley, David, Independent Treasury. 1910, months, interest at the rate of 2 per cent per pp. 26, 27. annum must be paid on this excess.

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CHART II Statistics of State Banks, 1836-1863

1846.1g The act provided that all safely without loaning, using or de- receivers of public moneys must keep positing them in banks. Further, on such funds as were received by them and after June 1, 1847, all payments of taxes, duties, etc., to the United 19 The repeal of the act in 1840 necessitated a States must be made in or silver return to the use of state banks as depositaries, gold until the act was repassed. or Treasury notes. New York, Phila-

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 6 delphia, Washington, Charleston, New to the want of any uniform system- Orleans and St. Louis were made the and to the significant fact that public principal centers of deposit. opinion was both torpid and unintelli- gent,&dquo;21 the losses to the people from STATE BANKS, 1836-1863 poorly-and dishonestly managed banks In the course of these years, &dquo; almost were enormous. Some of these banks every type of banking system was were established by special charters, attempted, and the result was the some, under the Free Banking Laws; accumulation of a great fund of experi- few seemed to have been prudently or ence&dquo; 2° mostly as to the best way in wisely managed. Some, called &dquo;wild- which not to conduct banking. In cat&dquo; or &dquo;red-dog&dquo; banks, were located New England and in New York the in remote sections, in order to keep efforts to regulate banking through their notes in circulation longer and state and private means were much render redemption more difficult. The more successful than in the rest of the lack of any uniformity in the bank country. Thus, by an act passed in notes, the failure adequately to protect 1829, New York State endeavored to them, and the absence of governmental protect both the depositor and note control were among the motivating holder by means of a safety fund which factors leading to the passage of the was built up by contributions from . the banks and which was to be used to BANKING SYSTEM meet the obligations (excluding capital) THE NATIONAL of the failed banks. This scheme was The national banking system, re- not very successful until, beginning sembling somewhat the free banking with 1842, the use of the fund was system of New York State, was recom- limited strictly to the redemption of mended by Secretary Chase as early the notes of failed banks. The notes as December, 1861. After two de- of the banks organized under the Free feats, due largely to the opposition of Banking Law of 1838 in New York the state banks, the bill establishing State were protected, not by the safety the system became a law February 25, fund, but by deposits of certain speci- 1863; but in accordance with the rec- fied bonds or mortgages with the state ommendations of Mr. Hugh McCul- comptroller. loch, the first Comptroller of the Cur- The success of the First and Second rency, it was completely revised and United States Banks led many states passed again on June 3, 1864. 22 to charter banks modelled upon these. The predominating motive in Secre- Among the more successful were the State Banks of Indiana, Louisiana and 21 White, Horace, Money and Banking. 1914, but the Bank of the Common- p. 331. Ohio, 22 The chief differences in these two bills were wealth of Kentucky, the Banks of as follows: Alabama, of Mississippi, of Arkansas, 1. The Act of 1863 required a smaller mini- of Illinois and the Union Bank of mum of capital for a new bank than did the Act Florida ended in dismal leav- of 1864, and required that a smaller proportion failures, be in before and allowed the citizens with millions of dollars paid beginning business, ing a longer time for the payment of the remainder. of unredeemed notes and worthless 2. The Act of 1863 permitted loans on real as deposit accounts. well as personal security. In the western and southern states, 3. The prohibition of issuing notes of a denom- ination less than took at once in the &dquo;due to the lack of $5 place public regulation, former act. 20 Willis, H. P., American Banking,1918,p. 212. 4. By the former act all national banks were

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tary Chase’s mind for the passage of of which 50 per cent was to be paid in the act was the establishment of a cashbefore commencingbusiness and the uniform currency. On January 1, remainder within five months at a rate 1862, there were in the United States, not less than 10 per cent per month.26 1,496 banks issuing some 7,000 different Each national bank was required to kinds of circulating notes, &dquo;based on a buy government registered bonds to great variety of securities, of different an amount not less than $30,000 or qualities and quantities,&dquo; 23 and some less than one-third of the capital stock based on no security at all. The fram- paid in. When such bonds had been ers of the Act not only wished to rid the deposited with the Treasurer of the country of such conditions as these, United States, the national bank would but it was felt by many also that the be entitled to receive notes up to 90 issues of notes were fre- per cent of the par or market value of quently redundant, were subjected to the bonds whichever was the lower, but violent expansions and contractions, no bank was permitted to issue an and were unequally distributed among amount of notes greater than its paid- the various states.24 in capital. Thus the circulation could The increased demand for bonds, at no time exceed the paid-in capital which such a system would create, of all the banks, and in addition an was to Secretary Chase a motive of absolute maximum of $300,000,000 was secondary importance.25 Additional placed on the note issues. The notes advantages of the system, of course, were to be receivable at par in pay- were that such banks could act as ment of all dues to the United States depositaries of government funds, float except for duties on imports, and to be loans, stimulate patriotism, and, be- paid out at par for all the debts of the cause of being a national system, pre- United States except interest on the vent future rebellions. public debt, and in redemption of the By the Act of 1864 the capital of the national currency.21 national banks was proportioned to It was further provided that na- the population as f ollows : tional banks in the reserve cities must Capitad make arrangements to redeem their Cities with a population of 6,000 currency in New York City, and, simi- or Iess ...... $50,000 26 The Act made an error in not proportioning Cities with a population of from capital to the bank’s liabilities instead of to the 6,000 to 50>000...... 100,000 population of the town in which the bank hap- Cities with a of population 50,000 pened to be located. The requirement that the and above...... 200,000 capital be paid in cash was an effort to stop the vicious practice begun at the time the First required to maintain a reserve of 25 per cent Bank was chartered of allowing the shareholders against notes and deposits. to contribute their part of the capital in their 5. The Act of 1864 makes more complete own discounted notes. provision for the conversion of state banks into 27 Inasmuch as the Loan Acts of March 3, national associations. 1863 and March 3, 1864, provided that both 23 Dewey, D. R., Financial History of the United principal and interest be paid in , and the States. 1918, p. 321. Loan Acts of February 25, 1862, June 30, 1864 24 Chart II, brings out the first two points in and March 3, 1865, provided for the payment a striking fashion. of the interest in coin, in order to help sustain 25 As a matter of fact, at the time of Lee’s sur- the public credit, it was necessary, therefore, as render, the bonds bought by the national banks specie payments were suspended from 1862 to to secure their circulation were less than 4 per 1879, that the government collect its import cent of the total bonds floated by the govern- duties in gold in order to obtain a supply which ment during the war. could be used as required by the above acts,

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 8 larly, national banks in country towns June 20, 1874, did away with the lawful must redeem their notes at some bank money reserve which was formerly located in a reserve city.2g required to be held against the circu- By an act passed on March 3, 1865, lation, provided for the 5 per cent $150,000,000 of the national bank redemption fund, provided that here- notes were to be apportioned among after banks would have to redeem the national banks in the several states their notes only at their own counters according to the respective populations, or at the Treasury Department, and while the remainder was to be propor- also provided that a bank which wished tioned by the Secretary of the Treas- to retire its circulation might with- ury &dquo;having due regard to the existing draw the bonds deposited with the banking capital, resources, and busi- Treasurer of the United States, pro- ness of such States, Districts, and vided that lawful money to an equal Territories.&dquo; amount be deposited to redeem the State bank notes were forced out of circulation still outstanding; but in no circulation by a provision in the case should the amount of bonds on Revenue Act of March 3, 1865, levying deposit for circulation be reduced a 10 per cent annual tax on the notes below $50,000.30 By the Resumption paid out after July 1, 1866. 29 Act of January 14, 1875, the provi- That the entrance of state banks sions in the former acts regarding the into the system was slow at first, was aggregate amount of national bank due, according to Mr. McCulloch, to notes in circulation and their distribu- the fear on their part that the national tion were repealed. banking system might be a repetition From 1882, when the national bank of the free banking system in its worst notes in circulation touched the highest aspects. Up to November 25, 1864, figure up to that time, 361 million dol- only 168 state banks had entered the lars, the amount outstanding declined system, but with the retirement of the rapidly until in 1891 there were only state bank notes in sight, only 244 re- 172 million dollars in circulation, and mained out by the end of 1868, and of this amount more than 50 millions 1,643 were members of the national were secured by lawful money. Nat- banking system. An amendment to urally one would expect a bank’s cir- the National Bank Act passed on culation to increase as the population 28 and the nation’s resources were New York was the only central reserve grew city, whereas the reserve cities were St. Louis, developed, but it must be remembered Louisville, Chicago, Detroit, Milwaukee, New that these bank notes based on govern- Orleans, Cincinnati, Cleveland, Pittsburg, Balti- ment bonds were alone of their kind in more, Philadelphia, Boston, Albany, Leaven- the and as the on worth, San Francisco, Washington City, and world, yield later, Charleston and Richmond. government bonds 31 was decreasing Banks in New York City were to keep on hand 30 By the Act of July 12, 1882, banks with a a 25 per cent lawful money reserve against both capital of $150,000 or less were permitted to notes and deposits, while banks in the reserve withdraw bonds, which they had deposited cities were to keep a 25 per cent reserve but one- against their circulation, down to one-fourth of half of this might be deposited with a New York their capital, provided that they deposit enough City bank. Banks in other towns must keep lawful money to retire the notes not covered by a reserve equal to 15 per cent, three-fifths of bonds, but not more than $3,000,000 of National which could be kept on deposit with a bank in a Bank notes were to be so retired in any one New York or in any reserve city. month. All bond requirements were repealed 29 State bank notes made their last appearance by the act of June 21, 1917. in the Treasury reports on July 1, 1876, when 31 By reason of the steadily rising prices of the the circulation was $1,047,335. bonds.

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 9 throughout this period, it was no longer this measure was to provide a basis for as profitable for the banks to take out the bond-secured national bank notes notes, as the so-called double-profit by postponing the maturity of a large had declined. From 1891 to 1899, the part of the public debt.34 -The tax on amount of national bank notes in- the notes issued remained at 1 per creased, due to the increased yield on cent per annum if the bonds bore more government bonds, and to special than 2 per cent interest, but if they demands for money during the panic bore 2 per cent interest or less, this of 1893. tax was reduced to one-half of 1 per cent. THE OF 1900 Under the stimulus of the Act, This act derives its name from the especially by reason of allowing na- fact that it provided that the dollar, tional banks to issue notes up to the par consisting of twenty-five and eight- value of the bonds, and by reason of tenths grains of gold, nine-tenths fine, the increased yield of government should be the standard unit of value, bonds, the amount of notes in circula- and all other forms of money should tion increased rapidly from 332 mil- be maintained at a parity of value lion dollars in 1900 to 609 millions in with the standard.32 1907. The Act also allowed national banks The Gold Standard Act of 1900 was with as small a capitalization as $25,000 not a constructive piece of legislation, to be formed in towns of 3,000 inhab- as it did little else than modify slightly itants or less.33 This led to a rapid the technical details in the organiza- increase in the number of national tion and operation of the national banks from 3,583 in 1899 to 4,165 in banks, and made no attempt to remedy 1901. any of the basic defects of our banking Though the notes to be issued by a system. national bank were at no time to THE PANIC OF 1907 exceed its paid-in capital, it was pro- vided that they could be issued here- Beginning with 1896, prices in the various standard nations, which after up to the full market or par value gold had been for a of the bonds deposited, whichever was falling nearly genera- tion, to turn This the lower, instead of only up to 90 per began upward. was due to an increase in the cent of such value. The refunding of change production of and use of the 5 per cent bonds maturing in 1904, gold money substitutes, and to the wasteful ex- the 4 per cent maturing in 1907, and ploitation of the world’s natural re- the 3 per cent maturing in 1908, repre- sources. The rise in the level senting a total amount of 839 million price led to such a stimulation of dollars, into 2 per cent bonds maturing industry that until 1907, aside from a local in 1930, was provided. One purpose of crisis in Germany in 1900 and the 32 This act simply affirmed the gold standard &dquo;rich man’s panic&dquo; of 1903 in America, which had been established in the act of really the was one of 1873 which demonetized the silver dollar. period general prosper- 33 As established by the Act, the capital re- 34 Horace White has estimated that the loss to quirements were: the government on additional interest paid by extending the maturity of these bonds amounted to $244 millions — a tremendous price to pay for an increase in circulation up to 1907 of only 277 millions of dollars. Money and Banking, Horace White. 1914, p. 406.

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 10 ity. This expansion in business and Toward the end of that year it was the resulting increase in speculation apparent that the demand for capital intensified the demand for capital. was such that borrowers had difficulty As the demand could not be met from in being accommodated even though the current savings of the people, com- bank credits were strained to the limit. mercial banks began to make larger In January and February of 1907 large and larger extensions of credit, a policy blocks of securities had to be sold to which resulted in progressively lower repay the loans previously procured reserves and forced the banks to raise from the London market through the discount rates and curtail extensions of drawing of finance bills. Prices of credit. This retrenchment was accom- stocks fell steadily and crashed in panied by a diminishing purchasing March. After a slight recovery the power on the part of the great mass of market began to fall again in August consumers, for wages lagged behind and was still falling when the panic prices in the upward movement, forc- occurred. ing the sale of products at sacrifice In addition to the general causes of prices. This condition checked the the world crisis of 1907, there were ele- rise in the price level and brought on a ments of weakness in the American period of depression throughout the banking system, reflected chiefly in world. the New York money market, which In America, as in the nations of caused the crisis here to degenerate Europe, prices, wages and interest into a panic. One of the most signifi- rates rose one after the other. While cant facts in the development of Amer- this differential between prices and the ican banking from 1896 to 1907 was the cost of production lasted, the specula- rapid growth of state banks and trust tor optimistically capitalized the future companies. State banks increased earnings of industry, and the prices of particularly throughout the West and stocks soared, reaching a peak in 1906. South as the requirements of the state

TABLE A-GROWTH OF STATE BANKS AND TRUST COMPANIES, 1896, 1902, 1907 STATE BANKS

TRUST COMPANIES

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 11 banking laws were less strict there than drawals during a crisis, a time when those of the National Bank Act. banks ought to increase their loans to The greatest growth in trust companies save the solvent but temporarily occurred in the East, as there they embarrassed borrower, is obvious. were not subject to the same strict Moreover, the Secretary of Treasury, requirements as were state and na- Leslie M. Shaw, encouraged other tional banks. The growth of these two unsound banking practices by a series types of banking institutions is shown of innovations which he introduced in Table A on the preceding page. from 1902 to 1907. Among the more A s the proportion of cash to the radical of his changes, was the exemp- individual deposits of state banks and tion of national banks from the main- trust companies, amounting to 8.3 per tenance of a cash reserve against gov- cent and 4.9 per cent respectively, in ernment deposits, the acceptance of 1907, was woefully inadequate to meet other than United States bonds as a heavy drain, they carried balances securities for,government deposits, the with national banks which they depositing of government funds where planned to withdraw in time of an money seemed tight, and the artificial emergency. On August 22, 1907, they stimulation of gold imports. had 196.3 million dollars on deposit The cause directly leading to the with the national banks in New York panic was the announcement, on City. Though these deposits would October 21, 1907, by the National Bank surely be withdrawn during a crisis, the of Commerce of New York that it national banks in the performance of would no longer clear for the Knicker- their functions as reserve agents, &dquo; did bocker Trust Company, whose man- not build up reserves any larger than agement was under suspicion. This they would have carried had they been action precipitated a run on the Trust received from that class of conservative Company, which was forced to sus- individuals who habitually maintain pend the following day after paying large balances with their banks out eight million dollars. Immedi- Furthermore the national banks in ately, the alarm spread throughout the New York City held a considerable land, a wild scramble for money ensued, porportion of the deposited reserves of banks and individuals hastened to the national banks located in the withdraw their funds from the New interior, amounting on August 22 to York City banks, and the panic was 213.8 million dollars.36 Against the on. The New York City banks being certainty of having the bankers’ bal- ill prepared to meet these heavy with- ances withdrawn during a crisis, the drawals were forced to suspend cash New York banks maintained the payments on October 26. The rest of ridiculously low cash reserve of 224 the country immediately followed their million dollars in 1906 (though this was example. slightly above the legal minimum) against total deposits (including those THE DEFECTS IN THE AMERICAN made by the government) of 1,162 BANKING SYSTEM AS REVEALED IN THE PANIC OF 1907 millions, of which at least a half con- sisted of bankers’ balances. That they One of the most serious of these would be unable to meet heavy with- defects was the rigidity and immobility of the reserves. The of 35 Sprague, O. M. W., History of Crises Under proportion reserves to be the National Banking System. 1910, p. 226. held by national banks 36 See footnote 37. against their deposits were definitely

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 12 fixed by statute.87 In compliance with brokers, as call loans, which they felt the provisions of the Act, on August were the most liquid form, in the ab- 22, 1907, national banks held cash sence of a general discount market. and deposited reserves as shown in The capacity of the interior banks to Table B. meet their depositors’ demands during The provision allowing a certain pro- a panic depended in part upon their portion of the reserves to consist of ability to withdraw the funds which balances with other banks was intended they had deposited with their New to provide the interior banks with ex- York reserve agent. But the New change to sell on New York and other York banks were unable to meet heavy important commercial centers. How- drains of cash, due to the insufficiency ever praiseworthy this intention might of their reserves, and the unliquid

TABLE B-CASH AND DEPOSITED RESERVES OF NATIONAL BANKS, AUGUST 82, 1907

Percentage of cash reserves against deposits =13.87°~/0. be, the provision led to a pyramiding character of call loans, secured by of reserves, so that our credit structure stocks and bonds, during a panic when represented an inverted pyramid with the prices of securities were tumbling. a relatively small cash apex in New Far from being able to repay his loans, York City. In fact, of the reserves the broker needed additional help from deposited with national banks in bankers at such a time.38 central reserve cities, more than two- Realizing that it might be impossible, thirds were held by the banks in New during a panic, to withdraw their York City. In August of 1907 they deposited funds, national banks placed held cash reserves against these bank- great dependence upon their cash ers’ balances amounting to 26.5 per reserves to meet the emergency. But cent, and, as was customary, had these, scattered as they were in 1907 loaned a large part of the remainder to among 6,429 banks, were ineffective in the When the finan- 37 allaying panic. The provisions were, that national banks in cial storm broke each little bank New York City, St. Louis and Chicago (known endeavored to and to as the central reserve cities) must keep a lawful strengthen guard money reserve of 25 per cent against their its own reserve against withdrawals, deposits; that national banks in some forty- as there was no established agency seven other large towns (reserve cities) must 38 maintain a 25 per cent reserve but one-half of Prof. Sprague finds that out of a total loan this might be deposited with a national bank in increase by the national banks in New York a central reserve city; all other national banks City between August 22 and December 3, 1907 were to maintain a 15 per cent reserve but three- of sixty-three million dollars, call loans account fifths of this might be deposited with national for fifty-four million dollars.—History of Crises banks in reserve or central reserve cities. Under the National Banking System, p. 301.

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 13 which would grant it aid through the money, rather than credit instruments, extension of loans or the discounting of is demanded as a medium of exchange. its paper. Once the reserve had fallen The suspension of specie payments, to the legal minimum, the bank was following the failure of the Knicker- not expected to extend any further bocker Trust Company resulted in a accommodation to its customers. The premium on currency ranging as high cash reserves of national banks, though as 4 per cent. The Honorable A. Piatt large in the aggregate, were so scat- Andrew has estimated that to meet tered, hoarded and immobile as to be the demands for money, 334 million ineffective during a time of financial dollars of currency substitutes were difficulty. issued, including loan Another defect in our banking sys- certificates and checks, cashiers’ tem revealed in 1907, as in every other checks and manufacturers’ pay panic, was the inelasticity of the na- checks.39 Our bank notes did not tional bank notes. An elastic currency begin to increase until the first part of should expand to meet seasonal and November and by the first of the year cyclical demands for money, and when had increased by only fifty-four million these demands have been satisfied, dollars. The reason is found in the should contract. Cyclical demands time it took to buy the necessary bonds occur at the time of a crisis, for then and to comply with the governmental business confidence is at a low ebb and red tape.

CHART III

39 Andrew, A. Piatt, "Substitutes for Cash in the Panic of 1907." The Quarterly Journal of Economica, August, 1908.

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Seasonal demands for money arise section to another, and had this cur- from periodically recurring needs, such rency contracted, once the need was as the demands of the farmers for satisfied, interest rates could have been money each fall to harvest and market fairly stabilized. Furthermore, due their crops. As the national bank to the immobility of reserves, and the notes failed to expand, the interior concentration of banking capital in the banks secured much of the money East, there were considerable sectional needed by withdrawing their deposits disparities in interest rates which from the New York banks. To the could not be eliminated without central extent that the New York banks met reserve banks. this demand with lawful money, their From time to time, the government reserves were lowered, necessitating a endeavored to extend relief to the contraction of loans and forcing up banks in order to counteract the evils interest rates. Chart III showing the in our banking system. The innova- seasonal variations (with secular and tions of Secretary Shaw have been cyclical tendencies removed) in the noted. Mr. George B. Cortelyou, his national bank notes and the notes successor, continued this policy. After issued by the Reichsbank, illustrates the panic had begun, he transferred to in a striking fashion the inelasticity the national banks in New York City of the former. (from October 21 to October 31) nearly Such powers of expansion and con- thirty-eight million dollars to help traction as the national bank notes them meet their withdrawals. Later possessed, depended upon the yield of he offered for sale 150 million dollars government bonds, for should this of bonds to stimulate the issue of increase, the double profit would rise national bank notes. The government and it would become profitable for had to choose between interfering in banks to force the notes into circula- the money market in this way or keep- tion. 40 ing its funds locked up in the sub- The seasonal movements of cur- treasuries. This latter policy would rency into and out of the New York have had the effect of making the cur- City banks, producing a dearth of rency redundant at the time the gov- money at one time and a plethora at ernment made disbursements and another, caused interest rates to vary scarce when its taxes were collected.42 from artificially low levels to abnor- mally high. Thus the average weekly 42 The Act passed in February 25, 1863 estab- low call money rate from 1890 to 1908 lishing the national banking system amended the Act so as was 2.31 per cent, occurring in the Independent Treasury to allow second week of June, while the national banks designated by the Secretary of average the Treasury to be depositaries of public funds, was 7.38 high, per cent,41 occurring in except receipts from customs. These banks the fourth week of December. Had were required to give security by the "deposit the seasonal demands been met, as was of United States bonds and otherwise." By an act passed on March 3, 1901 the of the true on the Continent, by an actual Secretary Treasury was expected to "distribute the depos- increase in the amount of currency, its herein—so far as practicable equitably be- instead of by shifting funds from one tween different States and sections." Secretary Shaw, in 1903, began to accept other than United 40 See pages 8 and 9 for a further illustra- States bonds from the banks against government tion of this point. deposits, interpreting the words "and otherwise" 41 Kemmerer, E. W., Seasonal Variations in the to mean "or otherwise." By the Act of March Relative Demand for Money and Capital in the 4, 1907 it was provided that receipts from cus- United Statea.—1910, p. 15. toms might be placed in designated depositaries.

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Of course such policies as introduced tain a reserve against deposits be by Secretary Shaw were but palliatives repealed.&dquo; for the situation and could not by On November 18, 1896, a resolution themselves remedy the defects of our was adopted by the Board of Gover- banking system. nors of the Indianapolis Board of Trade inviting representatives from EFFORTS AT REFORM the boards of trade of sixteen middle It was imperative that the defects western cities to assemble at Indian- in our currency and banking systems apolis in December of 1896 &dquo;for the should be remedied, if the nation were purpose of considering the advisability to escape the disaster, humiliation and of calling a larger conference,-to ruin of recurring panics. The members consider the propriety of creating a of the American Bankers Association non-partisan commission, to which were among the first to realize the shall be assigned the duty of formulat- necessity for reformation, and endorsed, ing a plan for the reform of our cur- at a meeting held in Baltimore in rency system. 1141 1894, a plan of reform known there- Representatives from the boards of after as the &dquo;Baltimore Plan.&dquo; This trade and similar commercial bodies plan proposed that government bonds of eleven of the cities invited attended be eliminated as security for national this preliminary conference and issued bank notes, and provided for their a call for a non-partisan monetary issue on much the same conditions convention of business men to con- that govern the issue of the Canadian vene at Indianapolis on January 1£, bank notes.41 1897. Delegates from twenty-six About the same time in a report to states and the District of Columbia Congress, Mr. John G. Carlisle, Secre- attended the convention, at which it tary of the Treasury from 1893 to was unanimously agreed that an 1897, proposed a plan of reform re- executive committee of fifteen be sembling in its main outlines the appointed which would endeavor to Baltimore Plan, but with the addition procure at the next session of Congress that the provisions in the National legislation for the appointment of a Bank Act requiring banks to main- Monetary Commission by the Presi- dent, to consider the entire question of and 43 The "Baltimore plan" proposed that gov- currency banking reform. In ernment bonds be eliminated as security for case this effort failed it was provided bank notes and provided that each National that the executive committee should Bank be allowed to issue notes up to 50 per cent of its paid-up, unimpaired capital subject to a 44 Carlisle’s plan closely followed the Balti- tax of one-half of one per cent per annum on the more plan, but differed in this respect that in average amount of notes outstanding, and further addition to the 5 per cent guaranty fund, he that an additional circulation, known as emer- would require each national bank issuing notes gency currency, equal to 25 per cent of the bank’s to maintain 30 per cent lawful money reserve, paid-up unimpaired capital be allowed subject consisting of United States notes including the to a heavier tax. Each bank issuing notes was Treasury notes of 1890, against the notes issued. to contribute an amount to a central guarantee State banks were to be allowed to issue notes in fund equal to 5 per cent of its notes in circula- accordance with these provisions. He also pro- tion, from which the notes of failed banks were posed that the provisions in the National Bank- to be paid. If the fund were not sufficiently ing Act requiring a bank to maintain reserves large for this, the remainder of the notes were against deposits be repealed. to be redeemed from the assets of the failed 45 Report of the Monetary Commission of the bank. A 5 per cent redemption fund was to be Indianapolis Convention, Chicago.—The Uni- maintained as at present. versity of Chicago Press, 1898. p. 5.

Downloaded from ann.sagepub.com at Bobst Library, New York University on June 18, 2015 16 select eleven men to make a thorough protect the noteholders from loss, each investigation of the monetary needs of bank was to contribute to a guaranty the country. The Commission of fund an amount in gold equal to 5 per Eleven was appointed and held their cent of its circulation, from which the first meeting on September 22, 1897, in notes of failed banks were to be paid. Washington. After a series of con- In case that the fund became impaired, ferences lasting through the fall, a by reason of payments made to redeem preliminary report was adopted on the notes, the Comptroller of the Cur- December 17, while the preparation of rency was authorized to make an the final report was entrusted to J. assessment upon all banks in propor- Laurence Laughlin, a member of the tion to their circulation. The present Commission. This report was com- 5 per cent gold redemption fund was to pleted by April of 1898. The prelim- continue. inary report simply states the Com- The plan for banking reform in- mission’s plan of reform, while the cluded the proposals that the present final report deals in an exhaustive way reserve requirements be maintained with the subject of money and banking against deposits with the exception that from a theoretical, historical and sta- one-fourth of the reserves required tistical standpoint, and is a note- should be held in coin in the vaults of worthy contribution to economics. the bank. The establishment of branch After advising that the existing gold banks was provided for in case the standard be maintained the Commis- Comptroller of the Currency approved. sion proposed that national banks be It was further recommended that the allowed to issue notes up to the organization of national banks in amount of their paid-up unimpaired towns of 4,000 or less with a minimum capital, exclusive of so much as is capital of $25,000 be permitted. invested in real estate. For the first The Commission’s proposals would five years after the passage of the pro- have provided America with a safe and posed measure, the notes issued up to elastic currency, but would not have 25 per cent of a bank’s capital were to remedied any of the other defects of be secured by government bonds, but our banking system. These could not thereafter the amount of bonds re- be removed by a modification of the quired to be deposited, before notes then existing system, but required the might be issued, was to be reduced by introduction of central reserve banks. one-fifth each year. The notes issued The work of the Commission is valu- in excess of 60 per cent of the capital able, not because of its immediate and not in excess of 80 per cent were to effect upon legislation, but for the be taxed at the rate of 2 per cent per reason that it awakened the public annum, while those issued in excess of conscience to the necessity of banking 80 per cent were to be taxed at the rate and monetary reform, and paved the of 6 per cent per annum. In order to way for the final reformatory measures.

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