“A Powerful Machine,” Part II: Lessons from the Death and Rebirth of the Bank of the

By Jay Cost July 2020

Key Points

• As discussed in Part I of this series, the First Bank of the United States was both a huge financial success and a political liability. • The same was true for the Second Bank of the United States. Chartered after the , the Second Bank was integral in reordering the national finances, but it facilitated both graft and political corruption. • The lesson of the bank has important policy implications for today because many con- temporary government programs mimic the style of the First and Second Bank and thus are susceptible to the same problems.

The previous report in this series examined the corruption that had marked the First Bank in the First Bank of the United States, noting that it was 1790s. From its chartering in 1815 until the Panic of essential to the successful development of the 1819, greedy and crooked branch managers took United States’ early financial sector but that it advantage of a feckless administration to enrich created negative externalities on republican gov- themselves at the expense of the country. And after ernment. Namely, the stockholders whom Alex- the election of 1832, Bank President Nicholas ander Hamilton favored came to acquire power used the elaborate power of the bank to influence far beyond ordinary citizens, which they used to the political process. pursue their own personal gain during the Panic of The lesson from the First and Second Bank is 1792. that while they may have been economically essen- Interestingly, the career of the Second Bank of tial, they were also politically dangerous. For the United States largely mirrors that of the first. modern leaders, the implication is that the bank’s The government allowed the first charter to lapse policymaking strategy—whereby private factions are in 1811, and its absence was sorely felt during the used as mediators for the public interest—can be War of 1812. So, in 1815 it was none other than Pres- simultaneously effective for securing government ident —one of the bank’s original ends and dangerous to the health of republicanism. critics—who signed the recharter into law. While this Second Bank performed ably for much of the **** 1820s, it nevertheless exhibited some of the same

AMERICAN ENTERPRISE INSTITUTE 1 The Bank of the United States was a central feature And over 20 years, a number of state banks had of Hamilton’s economic policy, but it became in sprung up across the country, which resented the turn a flash point of conflict for the party system influence of the Bank of the United States. Because that developed in the 1790s. After the Republicans taxes were often paid to the government in the took control of the government in 1800, they kept form of state-bank notes, the Bank of the United the bank in place—but many remained skeptical. States—which housed federal tax revenue—had In 1803, President reiterated the large quantities of these notes in its vaults and old grievance that the institution could threaten free could call them in to limit the state banks’ ability government in a letter to Secretary of the Treasury to lend. Their allies in Congress also opposed the Albert Gallatin on the potential opening of a branch bank. in New Orleans. “This institution,” he claimed, “is , a young senator from Kentucky one of the most deadly hostility existing, against who would soon come to be the leader of the the principles and form of our Constitution. . . . I “War Hawk” coalition agitating for war with Great deem no government safe which is under the vas- Britain, came out swinging against the bank in salage of any self-constituted authorities.”1 the Senate, revisiting the shopworn criticisms from Fortunately for the bank, Gallatin understood its 20 years prior. “What is the nature of this govern- utility. Although he was a committed Republican who ment?” he asked. made it his special mission to press for economy in government, he understood the bank’s importance; It is emphatically federal, vested with an it had become essential not only in the prolifera- aggregate of specific powers for general tion of private credit but also for the collection of purposes, conceded by existing sovereign- taxes and lending in times of public emergency. In ties, who have themselves retained what is this respect, he was alone among the high command not so conceded. . . . The power to charter of the Republicans, and he made the case for the companies is not specified in the grant, and bank to the president. I contend is of a nature not transferable by He told Jefferson he was “extremely anxious to mere implication.3 see a bank at New Orleans” because it would pro- mote “the transmission of monies arising both from Clay also warned that it was contrary to the the import and sales of lands in the Mississippi spirit of the government to play favorites and that territory,” which would be “a very difficult and the bank “invested” its stockholders and managers sometimes dangerous operation.” Gallatin thought “with exemptions and surrounded” them with nothing of the bank’s potential political power. The “immunities and privileges.” He waved the specter bank managers “are formidable only as individuals of corruption from the various corporations that and as merchants, and not as bankers. Whenever had “distracted and convulsed all Europe, and they shall appear to be really dangerous, they are menaced a total overthrow of all credit and confi- completely in power and may be crushed.”2 dence, and universal bankruptcy.”4 Ultimately, Clay Initially chartered in 1791 for 20 years, the bank’s and the anti-bank faction would prove victorious, impending expiration in 1811 renewed debate over for the bill to recharter failed narrowly in Congress the institution. By this point, Gallatin was still in early 1811. serving as secretary of Treasury, now to President This was an unfortunate turn of events, as the Madison, but his political influence had diminished country would find itself once more at war with significantly. He fought hard to get the bank rechar- Great Britain in a little over a year. The vacuum left tered but faced a formidable coalition in opposition. by the bank’s expiration posed a number of prob- The first among these were conservative Jefferso- lems for the government, the most pressing of nians who still held to the old view that the bank was which was its general inability to borrow . unconstitutional and dangerous to self-government. Gallatin and his successors at Treasury virtually Moreover, a group of “Malcontents” (as many in had to beg for funds, and effective rates rose as the administration had called them) hated Gallatin high as 7.5 percent—reflecting that capital-rich and wanted nothing more than to undermine him. New England was staunchly opposed to the war.

AMERICAN ENTERPRISE INSTITUTE 2 But the bank’s absence had other ill effects. Madison was never one to admit publicly that Gallatin counted some 120 new banks created he had been wrong, and this was about as close as between the dissolution of the bank and the end he could ever come: He was not wrong about the of the War of 1812. Many years later, he would constitutional merits of the bank per se, but rather recall the havoc they wrought. the country had disagreed with him, and he would assent to that judgment. In a letter written during The creation of new State banks in order to retirement, he argued that opposing the bank in 1815 fill the chasm was a natural consequence of “would have been a defiance of all the obligations the dissolution of the Bank of the United derived from a course of precedents amounting to States. And, as is usual under such circum- the requisite evidence of the national judgement stances, the expectation of great profits gave and intention.”7 birth to a much greater number than was In his seventh annual message to Congress, wanted. They were extended through the submitted in December 1815, Madison advised that interior parts of the country, created no new “the probable operation of a national bank will capital, and withdrew that which might have merit consideration.” He told Congress that “a been otherwise lent to government, or as uniform national currency should be restored to profitably employed. . . . And, as the salutary the community,” but until the “temporary evil” regulating power of the Bank of the United of an “absence of the precious metals,” Congress States no longer existed, the issues were had to find some kind of “substitute which shall accordingly increased much beyond what equally engage the confidence and accommodate the other circumstances already mentioned the wants of the citizens throughout the Union.”8 rendered necessary.5 That required a bank. In his roundabout way, Madison basically admitted in 1815 that Hamilton This proliferation of credit without underlying had a valid point. capital eventually forced the state banks outside New England to suspend specie (or hard cash) payments. This in turn effectively destroyed any semblance of a national currency. Unmoored from In his roundabout way, Madison precious metals, paper notes traded at varying basically admitted in 1815 that discounts throughout the country. Not only did this wreck the private credit markets, but it also Hamilton had a valid point. made it virtually impossible for the government to move its funds from banks where they were depos- A straightforward reading of the bank’s fall and ited to banks where purchases had to be made. resurrection gives the strong impression that By war’s end, it was clear that the bank had to Hamilton had been right and Madison wrong all be rechartered. Madison, who stayed mum during along. Reinforcing this interpretation is Madison’s the congressional debate over the bank in 1810–11, weak constitutional justification, which could be began advocating for it. In a January 1815 message read as a kind of “living constitutionalism” in to Congress, he “waiv(ed) the question of consti- which the meaning of the founding document can tutional authority of the Legislature to establish an be altered by subsequent generations so much that incorporated bank”—his original objection back previously unconstitutional acts could become in 1791—“as being precluded in my judgment by legal. It looks in historical retrospect as if Madison repeated recognitions under varied circumstances was searching for any rationale to bring the bank of the validity of such an institution in acts of the back into existence. legislative, executive, and judicial branches of the But this is too simple an account. For starters, Government, accompanied by indications, in dif- Madison’s constitutional hermeneutic was always ferent modes, of a concurrence of the general will a little bit inconsistent. Even in the 1790s, when he of the nation.”6 was objecting to the pillars of Hamiltonian finance

AMERICAN ENTERPRISE INSTITUTE 3 as unconstitutional, he was calling for federal sup- where managers lent recklessly and defrauded the port for scientific research and the chartering of government with abandon. Corruption at the Bal- a national university in Washington, DC. And Mad- timore branch was especially outrageous, where the ison was sensible that his latter-day justification managers stole nearly $1 million from the bank. By for the bank seemed to be a backdoor to plenary the summer of 1818, the branches were terribly power—for in one of his last acts as president, he overextended—with liabilities of some $22 million vetoed a bill that would have applied money the against assets of just $2 million. The collapse of government earned from the bank to internal the cotton market over the next year led to the improvements. His logic in rejecting the “Bonus , a severe economic that Bill” was that forced the overleveraged bank to contract its issues, which exacerbated the contraction. it does not appear that the power proposed It was the panic and the ensuing scandal around to be exercised by the bill is among the enu- the bank’s irresponsibility in the whole mess that merated powers, or that it falls by any just likely prompted Madison to write an essay expand- interpretation within the power to make ing on the dangers of corporations such as the laws necessary and proper for carrying into bank. No doubt, the former president admitted, execution those or other powers vested by they had their benefits. But their drawbacks had to the Constitution in the Government of the be kept in mind. United States.9 Banks, in their accommodations to prudent This, too, is hard to square with his admission of borrowers and in furnishing a currency more the bank’s constitutionality, given that the federal easy to be counted and transmitted than the government had already funded modest internal metals have acquired so many friends, that improvements, such as the Cumberland Road. if it were desirable to abolish them entirely On the other hand, Madison never abandoned and every where, the attempt would be his much stronger argument that the bank would hopeless. But the more impossible or inad- dangerously distort power relations within the visable it may be to abolish them, the more republic. His flip-flops, such as they were, consti- necessary it is to guard against the evils tuted an acknowledgment that the bank was (or resulting from their number, and against perhaps had become) constitutional, as well as the abuses incident to the ordinary consti- an admission that the bank’s economic benefits tution of them. . . . outweighed the political costs. But those costs remained substantial. For instance, publicly char- The greatest, certainly the most offensive tered corporations in Europe had come to exercise abuses of Banks proceed from the oppor- vast political influence and had at times wreaked tunity and interests of the Directors. They terrible economic havoc. In the early years after can obtain discounts for themselves, even the First Bank had been chartered, Hamilton had it is said to privileged amounts. They can effectively bailed out holders of bank stock despite suspend limit and resume the discounts to their extreme recklessness—an implicit admission others as they please: Their stations inform of the substantial political clout they had come to them of the wants and business of all who wield. deal with and depend on the Bank under The same would be true of the Second Bank of their management. With these advantages the United States, whose early years were marked alone they may by first lending money to by extreme incompetence and fraud that had themselves, and then immediately shutting disastrous economic consequences. William Jones, the Bank to others, with a knowledge of the who had served as secretary of the Navy and acting effect on others, carry on as secretary of the Treasury under Madison, was gainful as reproachful.10 named the first director of the bank. He did a poor Madison’s argument here is a variation of his job overseeing operations at the major bank branches, original position from 1791. A publicly chartered

AMERICAN ENTERPRISE INSTITUTE 4 bank could exercise power that it should not wield. This was the very kind of thing that Madison That may be for the purpose of creating a political had warned about some 40 years earlier when he machine, the kind he feared Hamilton was looking originally opposed the First Bank. Exclusive licenses to build 30 years earlier, or it may be simply to and privileges granted by the government to some enrich its managers. private entity are not necessarily one-way exchanges. In its later years, the Second Bank would take Such gifts can transform into political power, avail- on a distinctively political cast. After the Panic of able to the favored faction, for use against the 1819, Jones was ousted as manager of the Second government itself. Such was the case during the Bank in favor of former Speaker of the House , and such was the case during the , who successful restored sanity later phases of the “” of the 1830s. to its balance sheet. By the middle of the 1820s, under the new administration of Biddle, the bank **** was once again in a position to facilitate economic growth, which it did to enormous effect. Biddle The history of the First Bank is strangely similar was a financial savant who advanced the principles to that of the Second Bank. Both proved to be of central banking further even than his European absolutely essential to the growth of American counterparts had and was integral in proliferating commerce and integral to the maintenance of pub- the market revolution into the southern and west- lic finance. But both had also posed real problems ern regions of the country. for good governance, in that private factions—be they stockholders, branch managers, or, in the case of Biddle, the president himself—tried and in sev- eral cases succeeded in using their special privileges The bank was simultaneously essen- for their own purposes. tial to economic development during This helps clarify the debate over the bank. It is not that its advocates were right and its opponents the early republic and dangerous for were wrong, or vice versa. Rather, they were both the maintenance of self-government. right and wrong. The bank was simultaneously essential to economic development during the early republic and dangerous for the maintenance Yet Biddle ran into a problem in 1828 when of self-government. was elected president. Jackson The history of the two banks has widespread, had a deep suspicion of banks and strongly pre- practical applications to contemporary policy. In ferred the use of specie as the circulating medium. fact, the problems exhibited by mortgage giants In 1832, Biddle decided to push for an early renewal Fannie Mae and Freddie Mac before the financial of the bank’s charter, gambling that the pressure of crisis of 2008 were similar to the problems with the upcoming election would force Jackson’s hand, the Second Bank, and not coincidentally their given that the bank had proved most useful in his designs had a great deal in common. Both were electoral bases in the South and West. But Jackson public-private institutions that had special advan- responded by vetoing the bill to recharter the bank. tages over competitors because of the benefits That is when Biddle turned decidedly political. from their public charter; the bank housed federal He spent bank resources publishing campaign lit- tax revenues, while Fannie and Freddie had the erature advocating for Clay (who by this point had implicit backing of the federal government. These become staunchly pro-bank) over Jackson, and, privileges were extremely valuable and enabled when that failed, he responded by excessively con- both to engage in politics—as Biddle tried to do in tracting the bank’s credit issuances across the 1832 and as Fannie and Freddie did extensively. country, prompting a mild economic recession The entanglement between the government and during Jackson’s second term. A “steady course of these private organizations made it hard for the firm restriction,” Biddle believed, was necessary to former to regulate the latter, as was the case with force the government to agree to “the recharter of the Second Bank during its early years before the the Bank.”11

AMERICAN ENTERPRISE INSTITUTE 5 Panic of 1819 and with Fannie and Freddie until the but also the means to do so, from the very bounties . That entanglement also created they have been provided for by the government. moral hazards that induced reckless behavior on That was what was so shocking about Biddle’s the part of both—which led to the Panic of 1792 actions to contract credit in 1833. How did he have with the bank and contributed to the housing the power to do that? The government itself. Simi- collapse with Fannie and Freddie. larly, all manner of industry groups—medical ser- In sum, policymakers need to be extremely vice providers, defense contractors, agribusinesses, mindful in how private factions are brought into and so on—have the resources to lobby the govern- the project of governance. The bank was essential ment to influence public policy thanks to the benefits to economic diversification and modernization, a they receive from the government. key public purpose in the early 19th century. Like- Madison was wrong about the economic utility of wise, Fannie and Freddie created a robust sec- the bank, an error that he—in his own way—admit- ondary market for mortgage securities, which in ted in later years. But he was right to warn about turn facilitated the policy goal of homeownership. the dangers of such public subsidies. Government- Because they were private entities that made a sponsored monopolies, “though in certain cases profit, the bank and Fannie and Freddie accom- useful, ought to be granted with caution, and plished these goals at little cost to the govern- guarded with strictness against abuse.”12 What ment—or so it seemed at first. The reality is that that means no doubt varies from case to case. In the entanglement between private stockholders Madison’s day, he encouraged sunset and buyout and the public authority of the state can be easily clauses, and he was in general an advocate of misemployed or even abused. making sure the terms were clearly favorable to This policy lesson is not limited merely to the government. public-private corporations. The government These kinds of solutions are probably a good relies heavily on private interests to provide a idea for public-private corporations, but even they whole host of public purposes. Medicare provides have limits—for Fannie and Freddie, as well as the health care for senior citizens, but the government Export-Import Bank, another publicly chartered itself does not run the hospitals or employ the corporation, have historically been able to lobby doctors; it pays private practitioners. National successfully for recharters. Fannie and Freddie were defense is a core state function, but for the most also successful in the early 1990s in situating their part, munitions and other necessary matériel are regulator in the Department of Housing and Urban created by private corporations instead of the Development rather than Treasury because the government. The government manages the agri- former had less experience in overseeing financial cultural industry to keep farm prices stable partly institutions. In general, many federal commitments— through regulations but also through expansive such as Medicare and defense spending—are open- subsidies. Low-income citizens receive health, food, ended, if not by law then simply by fact. and housing benefits, but these are usually pro- Thus, policymakers need to be extremely careful vided through third parties. in crafting programs that employ private factions In each of these cases, the government employs for some public purpose. While such forms of a strategy of mediation—whereby the public pur- mediation are no doubt essential to policymaking pose is supplied by a private party, which receives and have been since the beginning of the country’s some kind of side payment from the government. history, that history also demonstrates clearly that As the case of the bank demonstrates, this can be such interests have been incredibly successful at a reliable way for the government to accomplish ingratiating themselves into the policymaking tasks for which it lacks the infrastructure. How- process and acquiring influence and power that ever, it also gives those third parties not just an does not square with the conventional idea of the incentive to involve itself in government affairs United States as a republican government by the people, rather than the special interests.

AMERICAN ENTERPRISE INSTITUTE 6 About the Author

Jay Cost is the author of The Price of Greatness: , James Madison, and the Creation of American Oligarchy (Basic Books, 2018). He is the Gerald R. Ford Visiting Scholar at the American Enterprise Institute and a visiting scholar at Grove City College.

Notes

1. Thomas Jefferson, letter to Albert Gallatin, December 13, 1803, Founders Online, https://founders.archives.gov/documents/ Jefferson/01-42-02-0100. 2. Albert Gallatin, letter to Thomas Jefferson, December 13, 1803, Founders Online, https://founders.archives.gov/documents/ Jefferson/01-42-02-0101. 3. Henry Clay, The Works of Henry Clay, ed. Calvin Colton, 6 vols. (New York: Barnes & Burr, 1863), 5:44. 4. Clay, The Works of Henry Clay, 5:45–46 5. Albert Gallatin, “Considerations of the Currency and Banking Systems of the United States,” Liberty Fund, https://oll. libertyfund.org/titles/gallatin-the-writings-of-albert-gallatin-vol-3. 6. James Madison, “Message to the Senate Returning Without Approval ‘An Act to Incorporate the Subscribers to the Bank of the United States of America,’” American Presidency Project, January 30, 1815, https://www.presidency.ucsb.edu/documents/ message-the-senate-returning-without-approval-act-incorporate-the-subscribers-the-bank-the. 7. James Madison, letter to Charles Ingersoll, June 25, 1831, Founders Online, https://founders.archives.gov/documents/Madison/ 99-02-02-2374. 8. James Madison, “Seventh Annual Message,” American Presidency Project, December 5, 1815, https://www.presidency.ucsb.edu/ documents/seventh-annual-message-0. 9. James Madison, “Veto Message,” American Presidency Project, March 3, 1817, https://www.presidency.ucsb.edu/documents/ veto-message-246. 10. James Madison, “Detached Memoranda,” Founders Online, January 31, 1820, https://founders.archives.gov/documents/ Madison/04-01-02-0549. 11. Quoted in Robert Remini, Andrew Jackson: The Course of American Democracy, 1833–1845 (Baltimore, MD: Johns Hopkins University Press, 1984), 111. 12. Madison, “Detached Memoranda.”

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The American Enterprise Institute (AEI) is a nonpartisan, nonprofit, 501(c)(3) educational organization and does not take institutional positions on any issues. The views expressed here are those of the author(s).

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