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Free and Wildcat Banking 1837–1863: "Free Banking" Era the Free Banking Era Was a Period Characterized by the Unrestrained Entry of Banks Into the Economy

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Free and Wildcat Banking 1837–1863: Free and Wildcat Banking 1837–1863: "Free Banking" Era The Free Banking era was a period characterized by the unrestrained entry of banks into the economy. Banks were not subject to any special regulations beyond those applicable to any other enterprise. The era spanned from 1836, after the Bank of the United States (BUS) federal charter expired, to 1865 when the federal government imposed a tax on state banknotes. The Independent Treasury System was established under President Martin Van Buren, who extended Andrew Jackson's banking policies. It was characterized by a monetary policy where each bank was allowed to issue its own currency and as a consequence control the overall supply and quantity of banknotes. There was an absence of governmental insurance that is in place nowadays to protect deposits in case of a bank failure. History and the Beginning of Free Banking Because Free Banking was a predecessor and natural alternative to monetary interventions, the theory and practice have been a subject to a great attention over the past centuries. Prior to 1837, establishing a banking institution in the US was a difficult and often politicized process as every bank needed a charter from the legislature of the state in which it was being founded and the number of available franchises were limited. The need for a new banking institutions appeared in 1836 when the Congress closed the Second Bank of the United States, a public institution with 25 branches across the country that helped to keep an adequate supply of money by limiting the number of notes issued. When its charter lapsed, there was a need for new financial establishments that would lend, invest, accept deposits, and issue money. New York State passed the first free banking statute in 1838, followed by Michigan. By 1860 some eighteen states had enacted a variant of the free banking law modeled by the New York law 1838. The rapid introduction of the laws is ascribed to the populist, anti-Mason, egalitarian Jacksonian politics combined with an inflationary policy that was mistakenly believed to be a solution to deflation induced by the Panic of 1837. The experience of Free Banking The free banking reforms were seen as a part of a greater struggle for liberty and hence much was expected from them. Free banking replaced special interest Free and Wildcat Banking legislation with a systematic “rule of law,” in a form of highly idiosyncratic, flexible, personalized charter conditions. It was expected that the elimination of the privilege associated with the Safety Fund System 1929 would decrease legislative corruption and log rolling, the number of banks would increase and they would be more rationally located, and the end effect of more available credit would encourage commercial and manufacturing businesses. A bulk of evidence suggests that the free banking laws indeed helped the growth of the number of banks. In 1800, there were only 25 banks in the United States and this number grew to 1,364 in 1860. The bank expansion varied significantly across the states; for example New York and Pennsylvania had 4 and 2 banks in 1800, and this number grew to 299 and 80 in 1860 respectively. Although the economic development in some areas might have had some influence on the discrepancies, the difference was most likely caused by different chartered policies in each state that controlled the reserve requirements, interest rates for loans and deposits, the necessary capital ratio etc. Many banks, however, failed to survive the period and provide a stable source of banking services, and a safe currency. In Minnesota, for example, between 1852 and 1854, 57 banks or eighty percent of the state's financial institutions, ceased operation. Wildcat banking and the failure of the Free Banking system Numerous banks that started during this period proved to be unstable, and many shut. It is widely believed that as a result of light governmental regulation, many dishonest bankers appeared and created a phenomenon called “wildcat banking,” which is believed to be the main cause of the downfall of Free Banking. Wildcat banking saw institutions defraud the public by issuing notes they could not redeem in specie (gold or silver). There are several theories about how the fraud occurred, the most well-known being that the banks discouraged redemptions by establishing offices in areas populated only by wildcat banks, far from the communities where they had circulated the notes. After making a profit, the bankers would close the bank and disappear with its assets. However, among the banks that closed between 1838 and 1863 only about 7% were identified as wildcats. In New York, Indiana, Wisconsin, and Minnesota between 1838 and 1863, almost half the free banks closed, but less than 7 percent of the free banks could possibly have been wildcats. Yet in these states between 1852 and 1863, most of the closings (about 80 percent of those that involved noteholder losses) Free and Wildcat Banking occurred during periods when bond prices strongly declined. And wildcat banking did not cause the declines. This leads to alternative explanations, such as that propounded by a well-known study by the Federal Reserve Bank of Minneapolis: that banks suffered losses because of the substantial drops in the price of the state bonds that made up a large part of their portfolios .
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