Banking in the antebellum United States was dominated by commercial banks, which were chartered by the individual states and limited in their operations to the state in which they were established. These banks typically accepted deposits, lent primarily to merchants, traders, and agricultural producers, and issued banknotes redeemable in specie (money in coin) on demand. Most loans were short-term, providing bridge funding to businesses. For example, merchants would typically borrow funds to purchase inventory, anticipating that the sale of those goods would enable them to repay the loan; or farmers and planters would obtain funds to cover the costs of planting and cultivation, repaying with the proceeds of the harvest. Often, loans were made in the form of banknotes, although increasingly draft accounts became part of the process. The exceptions to this general characterization of the period were the First and second Banks of the United States. These were institutions chartered by Congress for the purpose of operating both as a bank for the government and simultaneously as exceptionally large commercial banks serving the public throughout the nation.
The initial Bank of the United States was established in 1791 as a central component of Alexander Hamilton's vision for stabilizing the new nation's finances and for establishing a framework for the future development of the country's economy. The bank was given a twenty-year charter, and its structure followed the recommendations of Hamilton's Report on Banks, which in turn drew heavily from the model provided by the Bank of England. Capitalized at ten million dollars, of which 20 percent was subscribed by the federal government and a substantial portion of the remainder by foreigners, the bank provided financial services to the government, including holding tax receipts, making payments, and issuing debt. Thus the government was both an important owner of the institution as well as its most important customer.
As a federally chartered institution, the bank could extend its commercial operations across state lines, something denied to state-chartered banks. Thus branches were established throughout the nation. Its size and large holdings of state banknotes, combined with its ability to rapidly transfer state banknotes between branches and redeem them for specie when desired, enabled the bank to exert control over the entire banking system, ensuring that state banks did not overextend their note issue. The bank's ability to operate as a central bank, although used sparingly, ensured some stability to the system, but may also have served to retard the expansion of commercial banking in the first decade of the nineteenth century.
As the time for the bank's charter to lapse approached, pro- and anti-bank elements began a debate that would foretell events of the 1830s. In support of the bank, Albert Gallatin, who had been secretary of the Treasury under Jefferson, prepared a report on its operations and proposed a reorganization both to strengthen its role and to counter many of the concerns of those opposing the bank. Gallatin stressed the importance to the government of the central bank's functions, addressed the issue of foreign ownership, and proposed an expansion of the bank's capital, including encouraging states to subscribe in return for branches to be opened within their boundaries. Gallatin's report illustrates that at least some leading Jeffersonians had come to respect the wisdom of the arch-Federalist Alexander Hamilton, who had been the moving force behind the bank.
In spite of their best efforts, supporters of the bank failed to renew the charter when the vice president voted "no" to break a tie vote in the Senate. This failure had both political and economic foundations. Politically, the Jeffersonian Democrats' ideological fear of big government, of the bank's concentration of economic power, and of foreign ownership of bank stock were a powerful block to the bank. A general distrust of banks and a desire for hard currency or specie further strengthened their case against the bank. Economically, state-chartered banking interests saw much to gain by removing both a competitor and an overseer.
The void created by the disappearance of the national bank was quickly filled by state-chartered banks. The number of state banks increased from 117 in 1811 to 143 in 1812, or 22 percent in the first year after the First Bank of the United States wound up its affairs. By 1816 the number of state chartered banks grew to 232, or almost double the 1811 total.
With the outbreak of war in 1812 and the drying up of tariff revenues, the absence of a national bank forced the Treasury to rely on bond sales and the issue of Treasury notes to finance the war effort. Neither proved easy, and following the capture of Washington by the British in 1814, a general suspension of specie payment swept the country. This further devastated federal government finances, since it was forced to receive its revenues in depreciated state banknotes and Treasury notes. By the end of the war, Treasury operations were in disarray, and the nation's currency was composed largely of depredated, noncontrovertible state banknotes. As a result of the disruptions during the war, supporters of a national bank seized the initiative. They were able, after seven tries including one veto, to overcome the objections of the hard money interests and create a federal institution capable of operating multiple branches across the nation and powerful enough to establish a uniform currency to serve the Treasury's needs and to ensure control of circulation. Congress created the second Bank of the United States in April 1816, and in early 1817 banking operations began. The second bank's charter was constructed much like that of the first bank's, including a twenty-year time limit. One important difference was its capital of thirty-five million dollars, or over half of the total legal tender in circulation, thus making it the nation's dominant financial institution.
Under the incompetent management of William Jones, the new bank quickly moved to begin operations, restore confidence in the currency, and bring order to Treasury deposits and payments. Although stock in the new bank had been fully subscribed, little of the proceeds were in the form of specie. In addition, at the Philadelphia and Baltimore branches payments for the stock were made using balances from the bank itself. Those balances, in turn, had been created on the security of the bank's stock being purchased. Such corrupt actions damaged the new bank tremendously.
The inadequacy of specie across the country became clear on 20 February 1817, the date by which Congress required that all payments to the Treasury should be made in specie, Treasury notes, notes of the Bank of the United States, or in notes of banks payable on demand in specie. State banks were reluctant to resume specie payments but were persuaded to do so by the bank, which agreed in return to expand discounts for its customers by four million dollars in New York, Philadelphia, and Baltimore, and in Virginia.
Although the resulting convertibility was neither universal nor genuine, the bank did live up to its promises to expand loans. This action, combined with growing commerce across the nation and widespread land speculation in the South and West, meant the second Bank of the United States moved its portfolio into a position that would ultimately produce a panic in financial markets. Difficulties arose because of the bank's attempt to redeem at par the notes of all its branches wherever presented, the speed and extent of the loan expansion, and the reality that much of the increase took place in the rapidly developing areas of the Old Northwest and in the cotton-producing South. As a result of the rapid extension of credit by the second bank, state banks in the developing areas felt little pressure to contract credit and retire notes. In addition, Treasury receipts from taxes on an expanding import trade and the proceeds from speculative land sales were building credits in southern and western branches of the bank. The Treasury ultimately had to transfer credits from these debtor areas in order to satisfy their creditors in the East.
The result was a massive flow of banknotes from west to east. The situation reached crisis proportions in mid-1818, when eastern branches of the Bank of the United States refused to redeem in specie any notes but their own issues, including notes of other branches of the second bank. Meanwhile, the directors of the second bank instituted a policy of reducing discounts by five million dollars at the Philadelphia, Baltimore, Richmond, and Norfolk offices. With this move, the Panic of 1819 soon followed as the public lost confidence in the banking system.
With a monetary contraction under way, the Treasury Department continuing to repay debt, and as markets for American staples collapsed, the economy slid into a depression. Under a cloud, Jones resigned and Langdon Cheves became president of the bank in March 1819. Cheves directed two actions that strengthened the bank but hurt the economic recovery. First, he acted aggressively to increase reserve holdings, particularly in 1820. To the extent these reserve holdings were excessive, they retarded the expansion of the money supply at a time when such expansion was most needed. Second, rather than redeeming the bank's notes at any branch, he implemented a policy of making payments in state banknotes whenever possible. This protected the bank's specie holdings and did not expand its liabilities, but meant control over state banks was compromised at a time when restoring confidence in the system was critical.
In 1823 Nicholas Biddle was named president of the bank and moved to assume the bank's responsibilities for controlling the currency and stabilizing the economy by resuming the issue of notes and presenting the notes of state banks for redemption immediately upon receipt. These actions meant that state banks could not easily over-issue notes. Given the size of the second bank and its role as the bank for the federal government, it was continually receiving the notes of state banks and presenting them for payment in specie. Further, owing to the size of the second bank and its nationwide branches, its notes soon became a national currency, providing the bank with the ability to control this important element of the currency stock. As a result, the following decade was one of stability for the banking system and for the economy as a whole.
Despite its successes, the bank had many enemies. Among them was President Andrew Jackson, who upon his election in 1828 put the bank on notice that he opposed its being rechartered in 1836, the end of its initial twenty-year charter. Biddle, hoping to blunt Jackson's attack by making the bank an issue in the 1832 presidential campaign, pushed for a re-chartering of the bank in the summer of 1832. Jackson responded by vetoing the recharter bill, which Congress sustained, and making opposition to the bank a focus of his reelection campaign. Vindicated by his victory, Jackson moved quickly against the bank by ordering government deposits removed and placed in selected state banks, the so-called pet banks. With its large federal deposits gone, the bank was forced to reduce its activity and contract loans. Although Biddle may have pushed the reduction further than needed in hopes of forcing a reconsideration of the charter, the impact was relatively mild because specie inflows from abroad offset much of the bank's currency contraction.
With its government business gone, the bank continued to operate as just another large commercial bank until its charter ran out, at which time it became a state bank chartered by Pennsylvania. During this time an economic boom began, driven in part by land speculation, particularly in the West. Prices skyrocketed, and in an attempt to stem the land speculation Jackson issued the Specie Circular in August 1836, requiring all purchases of public land be paid for in specie. The Panic of 1837 brought the rampant speculation to a temporary halt, although action picked up again the next year. Finally, in 1839 a financial crisis led to large-scale suspension of specie payment by banks and ushered in an almost decade-long economic downturn. The Bank of the United States of Pennsylvania was one of the many banks that failed during this period.
The coincidence of the Bank War and subsequent destruction of the second bank, with the economic boom and following economic collapse, points to a critical role for the Biddle-Jackson battle. Yet economic analysis suggests more fundamental sources for the events of the period. During the period of the Bank War, the money supply increased dramatically as specie and capital flowed into the country from Mexico and England in response to political instability in Mexico and relatively higher U.S. interest rates. In addition, indemnity payments from France further increased the money supply. Changes in the lending behavior of state banks added little to the growth as they maintained their ratio of reserves to liabilities, while declining public confidence in banks worked to slow the growth of the money supply as the public decreased its use of banknotes.
With the economy booming and the money supply growing, the Specie Circular has often been pointed to as the cause of the Panic of 1837. Yet, analysis suggests that it was not Jackson's decision, but the action of the Bank of England to raise interest rates to cut the outflow of capital that played the critical role. A fall in the price of the nation's most important export, cotton, and the rise in interest rates combined to frighten banknote holders and lead to panic. The Bank War was not a direct cause of the panic, but it did change the public's confidence in the banking system, making it more susceptible to the shocks from abroad.
With the end of the second bank, the nation entered a period of free banking. Beginning in 1837, a number of states passed banking laws that enabled anyone meeting certain criteria to establish a bank. This free entry created the possibility of wildcat banks, fraudulent institutions established with little or no capital and designed to issue notes with no intention of redeeming them. Without the second bank to oversee the money supply, some suggest that the years prior to the Civil War were characterized by financial instability. Economic analysis indicates that, while for some periods in some states bank failures were important problems, the overall loss from bank failures was small, amounting, according to one estimate, to a transfer from note holders to wildcat bankers of less than one-hundredth of 1 percent of national income for the entire period. Offsetting these losses from free banking was an increase in competition resulting in lower cost for intermediation and an increased access to credit for many.
Although the demise of the second bank may have increased the cost of holding paper money as well as uncertainty, thereby retarding economic growth in the post-bank era, markets consisting of state and private banks and exchange brokers moved to replace many of the bank's functions. Measures such as the convergence of interregional interest rates suggest they succeeded. What markets could not ensure was an elastic currency, a money supply that could be changed with the needs of the economy. But acting as a true central bank was not something that leaders of the second bank fully understood nor had the means of accomplishing, given the bank's commercial banking business.