Bank failures: The Eighteenth and Nineteenth Centuries
After the United States achieved independence, banks were organized in major cities, mostly chartered by state governments. They received little government supervision. The banks financed their loans by issuing banknotes, which circulated as money. Fraudulent operators could print such notes, “lend” them to themselves, spend them a long way from home, and then disappear before the notes were presented for payment. The Farmers Exchange Bank of Gloucester, Rhode Island, for example, failed in 1809 with $800,000 in note liabilities and $86 in cash assets.
The first (1792-1812) and second (1816-1841) federally chartered Banks of the United States held the nation’s other banks accountable, constantly returning their notes for payment. The Second Bank aroused the ire of President Andrew Jackson and lost its federal charter. It became heavily involved in loans intended to raise the export price of cotton during the 1830’s, and it failed in 1841—the largest bank failure to that date. The economy experienced a violent boom-and-bust after 1837, and about one fourth of American banks failed between 1839 and 1842, reducing the money supply from$250 million during the mid-1830’s to about $170 million in 1841-1842. Banks that were not insolvent often temporarily suspended the conversion of their liabilities into cash and continued to operate.
Although a number of states established effective bank supervision, thinly settled frontier areas remained vulnerable to “wildcat banking.” Another boom-and-bust sequence occurred during the 1850’s, but by 1860, there were more than 1,500 banks. During the Civil War, the National Banking Acts of 1863 and 1864 authorized federal chartering of “national” banks. A punitive tax on state institutions’ banknotes persuaded most existing banks to join the national system. National banks could issue banknote currency, but only by pledging collateral of U.S. Treasury securities. Banknote holders were thus protected against loss.
Cash reserves were required for deposits, but banks outside the major cities could hold part of their reserves on deposit with a big-city bank, thus “pyramiding” reserves. The system was still vulnerable to panics involving deposits. One such panic in 1873 resulted from the failure of Philadelphia financier Jay Cooke’s banking firm, which was heavily invested in new issues of railroad bonds that it could not sell.