Understanding The S&L Mess


By 1866 there were more than sixteen hundred national banks; some two hundred state banks remained outside the system. Also outside the system, of course, were mutual savings banks, private banks, and S&Ls.

The comptroller of the currency, an officer in the Treasury Department, was responsible for regulating the national banks and quickly developed stringent standards, instituting such practices as unannounced visits by bank examiners, to keep the bankers on the straight and narrow. State banking departments began to adopt such ideas as well, and the number of bank failures caused by fraud quickly tumbled. The days of wildcat banking were over.

In the first seven years of the national banking system, there were only fifteen failures among national banks. That was still far too many, but it was much fewer than had been the norm in the 1850s. As the regulatory system became increasingly effective, the number of failures continued to decrease.

In 1863 a national banking system was created. It succeeded well at funding the war but less well at reforming banking.

The national banking system worked very well in the Northeast, but the defeated South, its liquid capital destroyed, had fewer than a hundred national banks, and none in Mississippi or Florida, where the steep capital requirements couldn’t be met. Likewise, many areas in the West were rich in land but poor in other forms of capital and could not obtain national bank charters. Still worse, national banks were forbidden to loan money on real estate, about all the West and South had for collateral.

This last restriction was intended to ensure the liquidity of national banks, whose deposits were mostly demand, but it infuriated those two regions, which were more than happy to transfer their Jeffersonian hatred of banks to the new national banking system. The number of banks in the state systems, which had much lower capital and reserve requirements, began to grow again and soon surpassed that of the national banks, although their total assets remained far smaller.

The loss of the power to issue bank notes, which, it had been thought, would kill state banking, turned out not to be vital anymore. Instead bankers created money simply by crediting the borrower’s balance in a checking account (a British invention). Their power to create money was unimpaired. Still, for the first time in its history, the United States had a uniform paper currency that was soundly backed and very difficult to counterfeit. The national bank notes were accepted as money from the beginning throughout the country, and they ended, at last, the currency chaos.

Thanks to the Jeffersonian inheritance, the national banks were forbidden to branch or operate across state lines, so the number of national banks grew quickly. There were 2,000 banks in the United States in 1866. By the turn of the century, there were 3,731 national banks and 4,405 state banks. The average bank size, however, was no larger, about five hundred thousand dollars in assets, than it had been thirty-four years earlier. Even the largest New York banks had only about thirty to forty million dollars in assets, nearly the same amount as in 1870.

After 1900, however, a divergence in American banking occurred. The country banks remained very small and grew ever more numerous (there were 30,000 by 1920), but the city banks mushroomed. By the 1920s New York’s First National City Bank (the forervnner of today’s Citibank) reached a billion dollars in assets.

In 1907 a great banking panic swept the nation, and the federal government, lacking any means to deal with it, had to call on J. P. Morgan to rescue American banking. Thanks to the crisis, however, the country finally acquired a central bank, the Federal Reserve System, in 1913. All national banks were required to be members of the Federal Reserve, and state banks that could meet the capital requirements (most could not) could join as well. The Federal Reserve stood ready to provide member banks with its bank notes in exchange for short-term commercial and agricultural loans held by the banks. The Fed, as it was soon called, thus acted as a lender of last resort in times of crisis.

This was the great advantage of being a member. The great disadvantages of membership were the new stringent capital and reserve requirements. The practical effect, unfortunately, was that strong banks joined the system and weak ones, which most needed the protection, did not.

Although the Federal Reserve was given the power to regulate some aspects of the national banks’ operations, the comptroller of the currency continued to regulate others. The reason for this absurdity lay in the intricate political negotiations that had been necessary to get the Federal Reserve created in the first place. Jefferson’s hatred and fear of Hamilton’s old Bank of the United States was still exerting its malignant influence a hundred years after Jefferson’s bucolic vision of America had begun to vanish.