Banking: From the Civil War to World War II


Banking: Early Banking

Banking: From 1800 to the Civil War

Banking: After World War II

Top Twenty Banks in the World, 2008, by Assets, in Millions of U.S. Dollars

In 1861, Secretary of the Treasury Salmon P. Chase proposed national banking legislation that was enacted in 1863 as the National Currency Act. For the first time, legislation defined the requirements for national bank charters and established examination and performance standards. These regulations provided stability to the institutions and thus allowed chartered banks to issue currency that would itself have a more stable value. The law also established the Office of the Comptroller of the Currency, a government agency responsible for examining national banks and enforcing the regulations. 

The National Currency Act created the first truly national currency. Although notes were issued by individual banks, they were entered on the books of the comptroller and stamped by the Treasury prior to issuance. Banks could issue notes only after they purchased sufficient U.S. Treasury securities from the government to stand behind those notes. Thus, the notes were effectively backed by the federal government. The added security of this backing reduced previous concerns about banknotes’ negotiability and value, resulting in a stable currency. These notes functioned as the national currency until the issuance of Federal Reserve notes in 1914. 

In an effort to reduce private banknote issues by state banks, the government began taxing those banks’ notes. This tax had the immediate effect of reducing the number of state banks. However, it also encouraged the development of demand deposits, or checking accounts. Such accounts allowed the transfer of money between bank accounts without the use of paper notes or currency, thus avoiding the tax. The tax also created the dual banking system of state and federally chartered banks. 

The new requirement that deposits be backed with Treasury securities created other problems. The value of these securities varied depending on prevailing market interest rates. When the value of Treasury notes fell as a result of rising interest rates, banks reduced loan availability to maintain proper reserve levels. Seasonal changes in liquidity resulting from shifts in farmers’ demand for cash also plagued the banking system. These two issues combined in 1907 to create a serious panic within the banking industry. 

A commission was appointed to find a solution to these problems; it recommended reestablishing a central bank. Six years later, the Federal Reserve Act, or Glass-Owen Act, of 1913 established the Federal Reserve and its twelve branches as the nation’s central bank. The new institution would issue Federal Reserve notes, direct obligations of the federal government, to replace the old bank-issued notes that had existed since the founding of the country. Thus the familiar national currency came into existence. 

The interior of the Dime Savings Bank in Detroit, Michigan, in the early 1900’s. (Library of Congress)

The Federal Reserve Act ushered in a period of relative calm in U.S. financial markets despite the disruptions brought on by World War I. Banks lent more money, providing a relatively easy and stable source of funds to support increased wartime production. After the war, production continued to expand to meet demand for goods. Credit remained readily available, allowing the U.S. economy to grow and consumer consumption to increase. Economic growth and the availability of money also encouraged speculation in the stock market. 

New stocks were issued to help finance the expansion of American business, and they were easily marketed to investors. At the time, the banks in New York not only held deposits and provided loans but also acted as the chief underwriters, buyers, and sellers of stocks. As a result, the same banks that created newly public companies’ stocks also provided loans to investors to finance their purchase of those stocks. During the mid- to late 1920’s, then, a person could borrow money from a bank’s loan department, then use that money to purchase stocks from the same bank’s securities department. This situation drove a wave of speculation and increased bank profits, until the speculation ended in October, 1929, when the stock market crashed. 
The crash brought about massive financial losses for individual investors. They sought to sell their shares before they could fall any farther, pulling what little cash they could from the market. Investors who had bought stocks with borrowed money were caught in margin calls: The value of the stock securing their loans fell below a predetermined level and was no longer sufficient to support the loans. Investors withdrew so much money from deposit accounts to cover these margin calls that many banks ran out of cash and were unable to pay their depositors. This downward cycle fed on itself, as bank runs caused several thousand banks to fail over the following three years. 

Shortly after President Franklin D. Roosevelt’s inauguration in 1933, two pieces of bank legislation were passed. The Emergency Banking Act closed every bank in the country for a four-day “holiday.” This closure provided time for bank examiners to review every bank in the country; they permanently closed those that seemed unable to survive and reopened those that had sufficient resources to weather the crisis. This process helped restore some of the public’s faith in the banking system. 

Later in the year, the Glass-Steagall Act was passed, arguably the most important banking legislation passed until its repeal by the Gramm-Leach- Bliley Act of 1999. This act prohibited commercial banks from acting as investment banks. It also established the Federal Deposit Insurance Corporation (FDIC), which provides insurance coverage of bank deposits (up to $100,000; increased in October, 2008, to $250,000). The FDIC further improved public confidence in the banking industry, and the financial markets once again began to stabilize. This was not a rapid process given the depth and breadth of the Great Depression. However, the slowly improving financial condition of the banking industry allowed banks to begin issuing loans again, and individuals had fewer concerns about the safety of their savings. World War II broke out in Europe just as the nation was recovering from the ravages of the Depression. This had the immediate effect of significantly increasing demand for industrial production, especially of war materials needed by the British. This sudden and substantial demand was happily assisted through increased lending by banks. As the war went on, production (and the demand for funds) continued to increase. Another effect of this growth was the rapid expansion of earnings by American workers and service members, leading to an increase in savings deposits. As more deposits were available to banks, more bank loans became available to borrowers, and the country found itself with a growing economy.

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