“A Powerful Machine,” Part II: Lessons from the Death and Rebirth of the Bank of the United States 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 War of 1812, 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 Biddle 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 James Madison—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 Thomas Jefferson 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 Henry Clay, 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 money. 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.