§ 1. The First and Second Banks of the United States. § 2. Bank-ing from 1836 to 1863. § 3. National Banking Associations, 1863-1913. § 4. Defects of our banking organization before 1913. § 5. Lack of system. § 6. Inelasticity of credit. § 7. Periodical local congestion of funds. § 8. Unequal territorial distribution of banking facilities. § 9. Lack of provision for foreign financial operations. § 10. The "Aldrich plan."

§ 1. The First and Second Banks of the United States.

The form of our present banking system has been affected by various economic and political events, a knowledge of which is helpful to an understanding of the present banking system in our country.

Alexander Hamilton, the great first Secretary of the Treasury in Washington's cabinet, advocated the charter of a central national bank as one portion of his larger plan of national financiering. His purpose was realized in the chartering, in 1791, of the First Bank of the United States for a period of twenty years. The capital for this institution was in small part subscribed by the government, but mostly by private capitalists. The management of the bank was left almost entirely in private hands. The central bank established branches in many parts of the country, issued banknotes which circulated everywhere without depreciation, acted as the governmental depository of funds and as governmental agency in various ways. It seems to have been successful and useful as a banking institution until the expiration of its charter in 1811, but it was touched by the contemporary controversies over state rights and was from the first opposed by those who feared the growth of a strong central government. This opposition prevented the extension of its charter.

In 1816, however, after only a moderate discussion, the Second Bank of the United States was chartered for a period of twenty years. This, also, in its purely banking aspects, seems to have been distinctly successful, conducting numerous branches in various parts of the country, maintaining at all times the parity of its notes, facilitating domestic exchange throughout the country, and enjoying unquestioned credit and solvency. However, this bank became, even in a greater degree than did the First Bank, the creature of political rivalries. In the period of rising democratic sentiment typified and led by Andrew Jackson, the bank came to be looked upon as the embodiment, or the stronghold, of plutocratic interests. Jackson's suspicions and hostility to a central bank were magnified by the untactful conduct of the head of the bank, and Congress permitted its charter to expire by limitation in 1836, near the close of Jackson's administration. In the light of history the change of policy must be pronounced unfortunate, the more so because it committed the then leading political party to opposition against a better organization of banking on a national scale. The action was directly that of Jackson, but the fixing of the blame is not an entirely simple thing.

§ 2. Banking from 1836 to 1863. The federal government, which up to that time had deposited its funds in the central bank and its branches, and in local state banks, established the "independent treasury" in 1840. This was abolished in 1841, but reestablished in 1846, and continuously maintained until January, 1921, when the Federal Reserve Board took over all nine of the offices and sub-treasury branches. By this plan the government kept its money of all kinds in various depositories (or sub-treasuries) in charge of public officials. While from 1792 to 1836 almost continuously a central banking system was in operation, other banks, organized under state charters, were steadily increasing in number. They received deposits, issued bank-notes under state laws, and cared for local commercial needs. The abolition of the central national bank in 1836 left to the various state-chartered banks for twenty-seven years all the banking functions of the country. A few of the states became stockholders in central state banks, or even undertook to conduct a banking business, with unsatisfactory results. The banks of some states (notably those of New England and New York), conducted as private enterprises under careful regulation and held to strict standards by public sentiment, for the most part maintained a high credit; but many banks, under lax laws and regulations, were guilty of great abuses of credit and of downright dishonest practices. The evils were more especially apparent in connection with excessive issues of bank-notes.

§ 3. National Banking Associations, 1863-1913. No further step was taken in federal legislation until 1863, when, in the midst of the Civil "War, local "national banking associations" were chartered. The purpose was in part to provide banks under national charters for banking purposes (both of deposit and of issue), and in part it was to make a wider market for United States bonds at a time when government credit was at low ebb. The plan adopted followed the experience of New York state (from 1829 on) with a system of bond-secured banknotes. Congress provided that every bank taking out a national charter must purchase bonds of the United States and deposit them with the Treasurer of the United States, in return for which it would receive banknotes to the amount of 90 per cent of the denomination or of the market value of the bonds, whichever was the smaller. (In 1900 this was changed so that notes could be issued to the full amount of the denomination of the bonds.) Notes of failed banks or of banks that go out of business are redeemed from the guaranty fund held at Washington and from the proceeds of the sale of the bonds. Bank-notes issued on this plan, being secured by the bonds and a redemption fund, rest ultimately on the credit of the government, not on the credit of the bank. They are not promptly sent back for redemption to the banks issuing them, as should be done if they were typical bank-notes. They may circulate thousands of miles away from the bank that issued them, and for years after the bank has gone out of business. They are perfectly safe for the holder, but are not an "elastic currency," increasing or diminishing with the needs of business. The changes in their amount depend upon the chance of the banks to make more or less in this way than by any other use of their capital, and this in turn depends largely on the price of bonds and on the rate of interest they bear. From 1864 to 1870 fortunes were made from this sources, but thereafter banks could make little more from note issues than they could by investing the same amount in other ways. Many banks for a long period did not avail themselves in the least of their privilege of issue. The notes were subject to a tax.1

A national bank (as the law now stands) may be organized, with $25,000 capital in towns not exceeding three thousand population, with $50,000 in towns not exceeding six thousand, with $100,000 in cities not exceeding fifty thousand, and with $200,000 in large cities. Three cities, New York, Chicago, and St. Louis, have long been designated as central reserve cities, and some forty-seven other cities as reserve cities, in which the reserves of banks have always been required to bear a considerably larger proportion to their deposits than in other cities.2 Other banks might, until 1914, count as part of their legal reserves their deposits in reserve city banks, up to a certain proportion. The national banks in the larger cities thus became the great capital reservoirs of cash for the whole country.

1 In recent years that has been one half of 1 per cent when 2 per cent bonds and 1 per cent when bonds bearing a higher interest were deposited.

2 In reserve cities 25 per cent and in other cities 15 per cent. The details of the regulations in the old law (given in part below, § 7) were all altered by the legislation of 1913, effective late in 1914.

National banks have been subject to stricter inspection than have been the banks in most of the states, a fact that has strengthened public confidence in their stability. Except in this and the other respects above mentioned, a national charter offered few, if any, attractions to small banks, a majority of which have found it more advantageous to operate under state charters because of less stringent regulations as to amount of capital, reserves, and supervision.