The Civil War in American Banks

The American Civil War [1861-1865] is not often thought of as a war to unify the banking system but President Abraham Lincoln might want us to think again.

For the first fore score and seven years of this democracy, a Southern-dominated Congress ensured there was no central banking authority, that all banks were chartered by the state, and the only currency available was through privately-owned state banks (called 'banknotes'). Money issued by the federal government was limited to gold and silver coins ('specie').

When the eleven states that would come to form the Confederate States of America left the Union, they also left vacancies in Congress. Lincoln took advantage of their absence by winning legislative battles long lost to Southerners.  This included both emancipation and national banking.

In 1863, just months after issuing the Emancipation Proclamation, the President signed into law the first National Bank Act, followed by a second in 1864. Lincoln understood that in order to keep the nation together, and prevent future rebellions, the United States would need a uniform currency. "It seems quite clear that the Treasury can not be satisfactorily conducted unless the Government can exercise a restraining power over the bank-note circulation of the country,” he told Congress.

These Bank acts created the first Government-sponsored paper currency as well as national banks to issue them. The national notes were called "Greenbacks" as unlike state banknotes they were printed on both sides, the reverse side in green ink. Additionally, they were given full legal tender, meaning they were required to be redeemed at full face value despite the fact that they were not backed by gold or silver.

Lincoln also gave the federal government more control over the banking system, marking the end of the Free Banking era. To instill confidence, rules for National banks were more stringent than state banks.  This included higher capital and reserve requirements as well as new rules designed to improve safety such as restricting real estate loans to any single person in an amount exceeding ten percent of the bank's capital. To ensure compliance, Lincoln created a new government department to regulate the institutions, the Office of Comptroller of the Currency. The OCC was given unprecedented powers, including the ability inspect the books of the national banks.

Understanding that a house divided cannot stand, his ultimate goal was to abolish state banks completely. At first, it seemed to be working, he told Congress in his 1864 State of the Union.

The national banking system is proving to be acceptable to capitalists and the people. On the 25th day of November [1864], 584 national banks had been organized, a considerable number of which were conversions from state banks. Changes from the State systems to the National system are rapidly taking place, and it is hoped that very soon there will be in the United States no banks of issue not authorized by Congress and no bank-note circulation not secured by the Government.

Lincoln knew, however, that he alone could not eliminate state banks. "Whether or not any further legislation is advisable for the suppression of State-bank issues it will be for Congress to determine." To hasten the death of state banking, in February 1865, Senator Sherman introduced a bill that would put a 10% tax on state banknotes. His argument for the tax was less about national banking itself, and more about the dangers of a dual-banking system. Since the national banks were intended to supersede the state banks, both cannot exist together, he told Congress. Furthermore,

if the state banks have power enough in Congress to prolong their existence beyond the present year, we had better suspend the presence of national banks.

The tax on state banks passed, however, state banks survived. And Sherman's warning of the dangers of a dual system have proved prescient, so wrote the Committee on Branch Group Chain Banking in a study commissioned for the Federal Reserve Board in 1933.

Many of problems of commercial banking in the United States today have arisen of the historical division of responsibility between the Federal and State government in chartering and supervising banks. Competition between the two systems has not only been an important factor in the incorporation in thousands of small banks, but has also led to the relaxation of legal regulations and has tended to diminish the effectiveness of supervision.

And here's why. State and National banks have been given a different set of rules. Prior to 1913, the National Bank Act prior did not permit the granting of loans on real estate, though state banks were free to do so. From 1863 through 1927, national banks were not allowed to open branches. States, on the hand, were. Lower capital requirements for state banks made them easier to open. And lower reserve requirements gave them more opportunities to lend. The competitive advantages conferred on the less regulated state banks made them more profitable, and put downward pressure on the regulation of national institutions. As the FRB's branch banking committee reported in in 1933, the battle between state and national charters created "a form of rivalry which has been described as a competition in laxity."

The MacFadden Act of 1927 lifted some of these restrictions, but it would not be until the 1990s when banks--state and national--could operate branches freely across the United States that the cavernous loop hole created by our dual system shrank.  But not completely.

Only today the situation is reversed. Nationally chartered institutions claim regulatory advantages over the more consumer-oriented state banks. Under  John D. Hawke Jr.'s leadership at the OCC [1998-2004] state attempts to curb predatory lending practices were rebuffed by the OCC. Hawke instead enforced federal policies that hindered states from reining in lenders, allowing nationally-chartered financial companies to claim that more restrictive state rules did not apply to them, according to an article in BloombergBusiness.

During the debates for the Dodd-Frank Wall Street Reform and Consumer Protection Act, the state vs. national division was central, with banks arguing for national standards, and consumer advocates fighting for stronger state supervision. Whether one is right or wrong is besides the point. Having two sets of standards is not good for our financial system.

In a 2011 letter to the OCC, Zion Shohet from the Citi's regulatory department said a dual system is simply impossible to enforce:

It would be extremely difficult for these banks to stay current on all state and local laws that could possibly apply to them across the United States, to be certain which ones would cover their activities, and to attempt to comply with such a multiplicity of different — and potentially inconsistent — requirements.

I imagine President Lincoln would be dismayed by the current dual state of banking in America. After all, a house divided against itself cannot stand. Furthermore, state banks are winning: 5,035 to 1,554.



References 

Sobel, Robert. The Big Board: A History of the New York Stock Exchange, New York, The Free Press,1965. Print. Nielson, Eric. “Monetary Policy in the Confederacy.” Federal Reserve Bank of Richmond, Fall 2005, pg. 40-43, Web. January 18, 2015.
http://ideas.repec.org/a/fip/fedrrf/y2005ifallp40-43nv.9no.4.html

Federal Reserve Bank of Philadelphia, First Bank of the United States: A Chapter in the History of Centralized Banking. June 2009. Web. January 18, 2015. http://philadelphiafed.org/publications/economic-education/first-bank.pdf

Engdahl, David. “Necessary and Proper Clause”, The Heritage Guide to the Constitution. Web. January 18, 2015. http://www.heritage.org/constitution#!/articles/1/essays/59/necessary-and-proper-clause

Hamilton, Alexander. “Hamilton’s Opinion as to the Constitutionality of the Bank of the United States: 1791”, The Avalon Project, Yale University, n.d. Web. January 17, 2015. http://avalon.law.yale.edu/18th_century/bank-ah.asp Chernow, Rob. Alexander Hamilton. New York, Penguin Press, 2004. Print.

Jefferson, Thomas. “Jefferson’s Opinion as to the Constitutionality of a National Bank: 1791”, The Avalon Project, Yale University. Web, n.d. January 15, 2015. http://avalon.law.yale.edu/18th_century/bank-tj.asp

Jackson, Andrew. “Veto Message: From the President of the United States, returning the Bank bill, with his objections, &c. [1831]”, Library of Congress, n.d. Web. January 13, 2015. http://memory.loc.gov/rbc/rbpe/rbpe19/rbpe194/19403000/001dr.jpg

“The Southern Rebellion.” The New York Times. January 11, 1861, Web. January 11 2015. http://www.nytimes.com/1861/01/11/news/southern-rebellion-exciting-charleston-confirmation-reports-relative-star-west.html

National Park Service. “Industry and Economy During the Civil War.” The Civil War Remembered, Virginia Beach, VA. Walsworth Publishing Company, 2014. Print. January 11, 2015. http://www.nps.gov/resources/story.htm?id=251

United States War Department. The War of the Rebellion: A Compilation of the Official Records of the Union and Confederate Armies. Pg. 698. Google ebook, n.d. January 11, 2015. Web. https://books.google.com/books?id=57I9AAAAYAAJ&pg=PA698&dq=alabama+an+onerous+and+unpleasant+duty+as+it+imposes+upon+the+state&hl=en&sa=X&ei=Dci7VMWRPMi5ggTomICgAw&ved=0CB0Q6AEwAA#v=onepage&q=alabama%20an%20onerous%20and%20unpleasant%20duty%20as%20it%20imposes%20upon%20the%20state&f=false

Lerner, Eugene M., “Money, Prices, and Wages in the Confederacy, 1861-65.” Journal of Political Economy, Vol. 63, No. 1 (Feb., 1955), pp. 20-40 The University of Chicago Press Article. http://www.jstor.org/stable/1826773

Lincoln, Abraham “State of the Union Address: 1864.” Infoplease, n.d. Web. January 11, 2015. http://www.infoplease.com/t/hist/state-of-the-union/76.html

Jaremski, Matthew, “State Banks and the National Bank Acts: A Tale of Creative Destruction.” Vanderbilt University. November 2010. Web. January 11, 2015. http://econ.as.nyu.edu/docs/IO/18865/Jaremski_20110218.pdf

Federal Deposit Insurance Corporation, “Statistics on Depository Institutions”, FDIC.gov. Web. January 11, 2015. https://www2.fdic.gov/sdi/main.asp

Berner, Robert and Grow, Brian. "They Warned Us About the Mortgage Crisis," Business Week. Oct. 9, 2008. Web January 22, 2015. http://www.businessweek.com/stories/2008-10-08/they-warned-us-about-the-mortgage-crisis 

Federal Reserve Committee on Branch, Group and Chain Banking, "The Dual Banking System in the United States." Feburary 26, 1930. https://fraser.stlouisfed.org/title/?id=808#scribd-open

A Good Old California Pioneer

American businessman and US Senator George Hearst was born on this day in 1820 in Sullivan, Missouri.

Hearst made his way to Sutter's Mill  in California in 1850 to try to reap his fortune, and for several years he was a successful miner and prospector. But it wasn't until 1859 that he hit the mother lode with the Ophir mine in Nevada. Flush with high-grade silver-ore, Hearst's discovery started the Nevada silver rush, and made him a very wealthy man.

Hearst spent the latter part of his career as a politician, representing California as a Democrat in the US Senate from 1887-1891. Today he is perhaps most famous for his son, William Randolph Hearst, to whom he gave the San Francisco Examiner, a newspaper purportedly acquired in repayment of a gambling debt.

Writing in his obituary in 1891, the Dallas Daily remembered Hearst as noble, tender-hearted, and:

"a good type of the old California pioneer...

His years of hard work and intimate mingling with men of every social and intellectual grade gave him a knowledge of human nature and a sympathy with its defects and weaknesses which kept him free from the pride of purse and hardness of feeling that sometimes go with the riches of the self-made man, and while he had a singular keen perception of character and a shrewdness that baffled all pretenders, his heart was tender, his charity great, and his capacity of forgiveness inexhaustible."

The Banality of Madoff

Bernie Madoff in October 7, 1999, photographed by Jonathan Saunders.

In the years since Bernie Madoff relocated to the Butner Federal Correctional Complex, it has been difficult for prosecutors to convict co-conspirators. Many of those involved claim that they were simply doing their job.

A lawsuit brought by investors in July 2013 reveals that the banker's at Madoff's custodial bank—Westport National—were, at the very least, not doing it very well.

When president Richard T. Cummings, Jr., a 36-year banking veteran, was asked at trial how the bank maintained accurate records he replied "I can't answer that question." What due diligence did the bank perform to ensure that customer assets were safe? “I don’t know.” Mr. Cumming has a finance degree from Georgetown (just saying).

Testifying by video deposition, the bank's vice president Dennis Clark said that he sometimes reviewed Madoff's trade confirmations out of “curiosity,” but then simply filed them away. Though Mr. Clark was the manager of custody services, he did not verify prices for derivative securities because he did not understand how puts and calls were priced.

Mr. Clark did, however, make an effort to look up stock prices listed on Madoff's monthly statements, in part because fees for the bank were based on assets under management—real or imagined.

In the end, the six jurors found that the bank breached its custodian agreements when it calculated its fees based on the Madoff firm’s reports instead of on the actual assets it held, and that the two plaintiffs had proved that the bank breached its agreements when it failed to issue accurate annual statements and failed to audit or verify the existence and value of the assets, the New York Times reported.

But the jury did not agree with the plaintiffs that economic loss occurred as a result of these (in)actions. A good day, overall, for sloppy custodial banks!

Many of the disputed custody accounts at Westport National were referrals from Robert L. Silverman, a professional actuary who ran a consulting firm about half a mile from the bank. "These investors were betrayed twice," Connecticut Attorney General Richard Blumenthal said in 2010. "First by Madoff and then by their advisers."

“I live in a tormented state now, knowing of all the pain and suffering that I have created," Madoff said at his sentencing in June 2009. "I am sorry,” adding abruptly, “I know that doesn’t help you.”

Train Wrecks

Jubilant board members of PNC Bank after receiving TARP funds.

Traveling 50 miles per hour, the engineer of a empty equipment train fell asleep. Idling on the same tracks was a circus train. Upon impact, the forty sleeper cars, constructed mostly wood and lit by kerosene lamps, derailed and caught fire. The ninety-four dead were charred beyond recognition.

While there were no animals injured in the wreck, the Hagenbeck-Wallace circus was famous for its animal acts, led by trainer Carl Hagenbeck. A pioneer of rewards-based training, Hagenbeck "was convinced that far more could be achieved by gentleness and sympathy than was ever accomplished by tyrannical cruelty," he wrote in his autobiography.


It was also known for its banking. In March 1904 Ben Wallace opened his own bank, the Wabash Valley Bank and Trust, after Peru National refused to process the circus' proceeds (barrels of nickels shipped in containers labelled "nails").  For eighty years, Wabash Valley operated on the corner of Main and Broadway in Peru, Indiana, with the third floor a workshop for making circus costumes.

After the train tragedy, Wallace and Hagenbeck sold the circus to Jeremiah Mugivan and Bert Bowers who renamed it the American Circus Company, then the American Circus Corporation. In 1929, John Ringling bought the ACC, and formed the largest circus in the world at the time, the Ringling Brothers Barnum & Bailey.

So, too, the Wabash Valley Bank and Trust eventually became the First of America Bank, then the National City Bank. In 2008, after the financial train wreck, the former circus bank was purchased by PNC Bank, a controversial merger at the time, PNC used TARP funds to finance the merger, just weeks after National City was denied those funds.

Describing how the $700 billion bailout was distributed to the banks, former director of the Office of Thrift Supervision Tim Ryan admitted it was “a four-ring circus.”

The Sinking of the Germania Bank

Illustration is from Puck, a magazine founded by German immigrants, and shows an old, haggard "Justice" sitting in a chair on a rock in the East River, cobwebs have grown over her sword, scales, and an "Indictment"; in the background, the steamship General Slocum is engulfed in flames (it burned on June 15th 1904 with a loss of over 1,000 lives). From LOC.gov

On a sunny, June 15th Wednesday in 1904, a steamboat called the General Slocum carrying parishioners from St. Marks German Lutheran Church to its annual picnic erupted into flames and sank in the East River. Almost all of the 1,021 killed were women and their children.

The Pastor, who survived, described the scene. "Women were shrieking and clasping their children in their arms. Some mothers had as many as three or four with them. Death by fire was to be escaped only by death by water."

Passengers who chose water were horrified to realize that the boat's "life preservers" (which hadn't been replaced since 1895) were filled with ground cork instead of solid. Since most Americans could not swim at the time, many, including the Pastor's wife and daughter, drowned. In the preceding trials, the captain and crew escaped punishment for their part in the greatest loss of life in New York's history (until 9/11/2001).

In the days that followed, the avenues and byways of Little Germany that had for generations been famous for outdoor gaiety were silent. Mourning crepe hung on every door. The windows wept.

"We all knew each other and now--all dead," a grief-stricken resident told the New York Times.

Many attributed the Slocum tragedy to the eventual death of Little Germany itself. But the transition from Kleindeutschland to what we now know as the East Village was certainly hastened by a wave of anti-German sentiment. German bier gartens were the bete noir of the Prohibition Movement, and the onset of World War I brought hatred of Germans to a frothy peak.

The New York Times ran letters defending German-Americans. "Of all the peoples of nations that have come to our shores there are none who have made better or more patriotic citizens," John Crimmins wrote in 1914. "Steady, industrious, sober, [German immigrants] have given to the United States great merchants, manufacturers, and bankers."

Including the bankers of Little Germany's own Germania Bank. Successful since its founding in1869, it drowned in 1918 under the weight of anti-German feeling. When it was apparent that there was no place in America for a bank with German in its name, the well-capitalized and deposit-rich concern changed it.

On April 15th a small corner of the New York Times made the announcement: "Beginning today the Germania Bank will be known as the Commonwealth Bank."

Post Script: The Germania Bank Building survives to this day. Described by New York Magazine as a "72-room Bohemian dream house," the former bank is now the home of photographer Jay Maisel who purchased it in 1966 for $102,000. He still lives there with his wife and daughter, though from the outside it looks vacant. The inside, however, a-mazing. Check it out here.

On the Death of John Pierpont Morgan

John Pierpont Morgan and Uncle Sam rowing a boat, circa 1911. From LOC.gov.

You might think I was April Foolin' if I said that there was a time when the death of a banker caused national mourning. But such was the case on April 1, 1913.

"World Mourns Loss of Great Financier," the New York Sun headline ran reporting on the death of John Pierpont Morgan. Flags flew at half-mast. The New York Stock Exchange suspended operations.

Though Mr. Morgan was 76 when he died, his demise was attributed to "emotions caused by the investigation carried out by the Pujo committee." Formed in May 1912 by Arsène Pujo of Louisiana, the congressional subcommittee's purpose was to show that the "panic of 1907 was a manufactured panic which would have been impossible had it not been for the concentration of money and its control in a group of Wall St. financiers," reported the San Francisco Call in December 1912.

Newspaper reports that the House of Morgan controlled $25 billion, a large sum even by today's standards, startled everyday Americans whose average salary at the time was $800 per year.

Congressmen denied the accusations. "The insinuation that the committee's courteous examination of Mr. Morgan contributed in any manner whatever to his demise appears to be a studied attempt make capital (hah!) of his death, and to arouse sympathy for a system that in many respects is at a decided variance with the interests of our people," Congressmen Neely of Kansas said in the Washington Times.

In the end, it was the Congress that capitalized. Within a year of Morgan's death, sweeping legislation designed to redistribute wealth was enacted, including: the 16th Amendment (1913) giving Congress the power to levy income tax; the Clayton Antitrust Act (1913) to reign in monopolies; and with the Federal Reserve Act (1914) government-sponsored centralized banking.

While the cause of JPM's death was in dispute, his impact was not, at least according to the many condolences reprinted in the New York Tribune.

"It is hard to give an estimate of the loss which the entire country has suffered through Mr. Morgan's death," wrote fellow banker Joseph Harriman. "He was a great organizer and developer and the monuments that he reared will live for all time. Not the least great and lasting work to his credit is the wonderfully equipped banking firm he has left behind him, which will perpetuate his name for many years to come."

Indeed, today, with over $2 trillion in assets, JP Morgan Chase is the largest bank in the United States.

Asheville's Depression Debt Redemption

Asheville's historic Legal Building

On March 24, 1663, King Charles II granted a land charter for the Province of Carolina (named after his father, Charles I, Carolus being the Latin version of 'Charles') to eight Lords Proprietors, a form of repayment for their help in restoring him to the throne.

On another March 24, Samuel Ashe, the ninth governor of North Carolina, was born in 1725. Ashe is the namesake for many parts of the state, including Asheville.

The Miami Beach of the Mountains, Asheville is "the happiest city in America" according to Self Magazine. But it wasn't always so, at least for bankers.

On November 20, 1930, eight North Carolina banks failed, including Asheville's largest Central Bank and Trust. Thousands lost their life savings, including the city itself. With $8 million gone in a single day, projects halted, employees lost salaries, the budget was cut in half.

An independent audit of the city's finances found that officials used public funds to try to save the bank. Their efforts were not appreciated. "Even if the city's commissioners pursued the course they thought best," the New York Times reported, "as public officials they have destroyed themselves plunged the city headlong into debt, betrayed their trust and forfeited the right to their possessions."

The bankers took it hard. On February 17, 1931, the vice president of Central, Arthur R. Rankin, shot himself to death. Later that week, a bank cashier cut his throat but survived. On February 23, four days after bank and public officials were indicted for fraud and conspiracy, Asheville mayor Galatin Roberts went to the fourth floor bathroom of the Legal Building and shot himself in the temple. He left a note.

"My soul is sensitive and I am wounded unto death. God knows I did no wrong during my term in office. My hands are clean and my conscience is clear."

With the largest municipal debt per capita of any American city ever, Asheville experienced four decades of economic stagnation and population decline. Bankruptcy might have been easier, but the community refused. "We owe this money and we ought to pay it," Asheville city employee Weldon Weir explained. Each year as bonds were retired, the Asheville Citizen ran a headline "Bonds Cremated." The last payment was made in 1976.

Though it wasn't easy, the experience is treated as a blessing.  In the go-go 1960s when other cities were destroying buildings to "modernize" (e.g, New York's Pennsylvania Station), depression-era debt payments forced Asheville's skyline to stay beautifully stuck in Art Deco-y 1930, "and is why our historic fabric was not bulldozed," writes Ashevillenow.com.

Today, with debts repaid and conscience cleared, Governor Ashe's namesake town is a downright happy place to be.

Mississippi's Mixed-up 13th Amendment

Portraits of Blanche Kelso Bruce, Frederick Douglass, and Hiram Rhoades Revels surrounded by scenes of African American life and portraits of Jno. R. Lynch, Abraham Lincoln, James A. Garfield, Ulysses S. Grant, Joseph H. Rainey, Charles E. Nash, John Brown, and Robert Smalls. Crica 1883, from LOC.gov

March 16 marks the anniversary of Mississippi's ratification of the 13th Amendment, the one that proclaims "Neither slavery nor involuntary servitude shall exist within the United States." March 16, 1995, that is.

The 13th Amendment became part of the Constitution in 1865, after three-fourths of the states adopted it, but four took their sweet time: Texas ratified in 1870, Delaware 1901, Kentucky 1976, and Mississippi 1995.

To make matters more delayed, it wasn't until last year that the ratification was official, since the Mississippi legislature forgot (?) to let the US archivist know. After being inspired by the movie "Lincoln," Dr. Ranjan Batra, a professor of Neurobiology at the University of Mississippi, worked with the state archives to fix the clerical oversight, ABCnews reported in February 2013.

Back in 1865, Mississippi's Memphis Daily clarified that their opposition to the amendment was not to the first section outlawing slavery "as the slave states themselves have in convention solemnly decreed emancipation," the newspaper wrote in November. Rather it was the second section that was "amenable to grave objection to every man who is sensible of the high duty of preserving the state sovereignty feature of a mixed government."

The second section states that "Congress shall have power to enforce this article by appropriate legislation."

This encroachment on states rights, the editors declared ironically enough, made its citizens less free. They likened its passage to Napoleon III's 1851 "bloodless coup d'etat that passed France from a Republic to an Empire. The nation went to bed in a polity of freedom and woke up to find masters." (I guess no one likes to be a slave.)

While Mississippi was advocating for laws that disenfranchised its majority black population (just 45% of Mississippians were white at the time), they were also electing 226 black Mississippians to public office, compared to only 46 blacks in Arkansas and 20 in Tennessee, according to the Mississippi Historical Society.

Mississippi also sent the nation's first and second African-Americans to the US Congress, Hiram R. Revels who served an incomplete term 1870-1871, and Blanche Kelso Bruce who served a full term 1874-1881.

Political progress was not enough for the prejudice seared into hearts and minds, concluded Colonel Samuel Thomas, the assistant commissioner of the Freedman's Bureau.  Though white Mississippians “admit that the individual relations of masters and slaves have been destroyed by the war and the President's emancipation proclamation, they still have an ingrained feeling that the blacks at large belong to the whites at large,” Colonel Thomas told lawmakers in 1865.

Between 1881 and 1898, however, America's currency at large belonged to Mississippi Senator and former-slave Blanche K. Bruce. Senator Bruce was appointed by President Garfield to be the Register of the Treasury, making him the first African-American whose signature was represented on U.S. paper currency.

When he was re-appointed by President William McKinley in 1897, editors at the Washington Bee were unequivocal.

"Newspapers of all shades of politics agree that in the appointment of exSenator Bruce to the Register of the Treasury, President McKinley has made an admirable selection."  Editors from the Herald in Rochester, NY concluded, "Blanche K. Bruce, the new Register of the Treasury, is of African decent, but the name on a greenback is not to be sneezed at."

Senator Bruce died one year later, on March 17, 1898.

In Fed We Trust

President Herbert Hoover escorting Franklin Delano Roosevelt from the White House to the Capitol to take the oath of office as President, March 4, 1933. From LOC.gov

Trust is a funny thing. It can build empires and be broken by a promise. It is gained slowly but lost quickly. While not essential for life, we can't live without it. And in March 1933 it was in short supply.

The root of the bank crisis that led to the Great Depression can be traced to a promise broken by the Federal Reserve, so argued Milton Friedman and Anna Schwartz in their seminal book "Monetary History of the United States."

Established in 1913, in the wake of the 1907 panic, the Federal Reserve was designed to prevent major bank failures by acting as the lender of last resort. Prior to the Fed's creation, as Ben Bernanke explained in a 2002 speech, bank panics were typically handled by banks or bankers themselves. Large, solvent banks had an incentive to act because they knew that an unchecked panic would ultimately threaten their own finances.

But there was always a fear that "men may not be found in an emergency with the patriotism, courage and capacity" necessary to prevent a catastrophe. This was one of the arguments for central banking put forth by Senator Nelson Aldrich in the wake of 1907 crisis.

That isn't to say that Americans feared bank failures. Liquidationist believed that by weeding out "weak" banks, failure was a harsh but necessary component of a healthy banking system. Between 1921-1929, an average of 600 banks failed every year, according to FDIC data. Treasury Secretary Andrew Mellon advised President Hoover that it was not the Fed's job to rescue poorly managed, failing institutions.

So they didn't. In December 1930 (a year after the market crash) the Fed refused to bailout New York's Bank of the United States.* But it was not managerial weakness, per se, that caused the BUS to fail. In November, the announcement that merger negotiations between the BUS and three other banks broke down "aroused distrust in the general public," according to the New York Times. In December, a false rumor that a shareholder had not been paid for his shares sparked a run that eventually forced the bank into a liquidity crises.

When the Fed refused to insure the bank's liabilities, Americans felt duped. Unlike the small bank failures that occurred during the 1920s, the BUS was a member of the Federal Reserve System. It was also the largest ever to suspend payments, "possibly the largest in the world to close its doors." Letting it fail caused thousands to lose their life savings, and severely diminished America's faith in the Fed's ability to prevent major bank failures.

In October 1931, after Great Britain's abandonment of the gold standard sparked a run on banks, a consortium of private bankers attempted to fill the gap by organizing the National Credit Corporation. But with the existence of the Fed--the purported lender of last resort--not enough felt the need to step-up, and the organization failed within weeks.

Business leaders then appealed to the federal government. In January 1932, the Hoover Administration created the Reconstruction Finance Corporation (RFC) whose primary function was to make advances to banks, and failures subsided. By the end of 1932, the RFC had assisted over 4,000 banks and authorized almost $900 million in loans. But the appearance of a bank's name on the RFC list was interpreted as a sign of weakness,  ultimately discouraging banks from accepting its assistance.

In the winter of 1933, faith in the nation's banking system reached a nadir. The fear contagion started in Michigan on Valentine's Day. Trying to prevent the failure of Detroit's large banks, Michigan Governor William A. Comstock declared a statewide banking holiday. This succeeded in preventing bank failures, but also confirmed the public’s worst fears—that the banks needed to be closed.

As depositors in every state lined up outside bank branches, failure became a self-fulfilling prophecy. On March 5 (barely a day in office), FDR shut down all of the nation's banks, proclaiming what is known today as the Bank Holiday (a misnomer if ever there was one).

On March 9, he signed the Emergency Bank Act, declaring a sort of Martial Law on the nation's economy. The Act gave the President control of the entire banking system, and nearly unlimited resources to resolve its problems. This hasty legislation (only one copy was made and Congressmen cast their vote after having it read to them aloud) was the first bold move the President made to restore confidence.

The second occurred on March 12 (a Sunday) with the first-ever "fire side chat." At 10 PM, radios nation-wide broadcast his avuncular assurances. Using understandable language,  FDR clarified the state of America's banks. Fear abated. On Monday, depositors stood in line to re-deposit their cash.

In November 2002, at Milton Friedman's 90th birthday, Ben Bernanke thanked the Nobel-prize winning economist for his insights. "Regarding the Great Depression," Bernanke gushed, "You're right, we did it. We're very sorry. But thanks to you, we won't do it again." 

In 2008,  Ben Bernanke's Federal Reserve kept his promise. Many agree his bold and decisive actions prevented another Great Depression, though those actions were deeply unpopular.

There's no denying that by shifting the responsibility of providing liquidity in financial crises from the banks (who for the most part created the problems) to the people via government guarantees, the existence of the Fed creates a moral hazard. This is an unsavory reality. What central bankers learned from 1933, however, is that as long as the Fed exists it must keep its promises or be destroyed by them.

Watch Milton Friedman discuss the failure of the Bank of the United States and the anatomy of bank runs on YouTube.

*Things might have been less severe if the Bank of the United States had a different name. "Though an ordinary commercial bank," Friedman wrote, "its name had led many at home and abroad to regard it as somehow the official bank."

America the Binary

"Siamese Twins," Brothers Chang and Eng Bunker, a symbol of America?

At protests, we often hear the phrase "the people united will never be defeated." But in America, we are wise to remember another phrase: "never say never."

Take the election of 1824. While first thought to unify the country, America's brief experiment with a one party system (1818-1824) led to a un-popular conclusion in 1824. With all four candidates representing the same party, the Democratic-Republicans, none received a majority of the electoral votes, and the US House of Representatives was left to decide.

Despite receiving a plurality of both the popular (43%) and electoral votes (99), General Andrew Jackson was defeated by his runner up, John Quincy Adams. Under what Jackson supporters later dubbed the "corrupt bargain," Congress elected Adams to be the sixth President of the United States on February 9, 1824.

Jacksonians were furious, and within months had nominated him to be the1828 presidential candidate (Hilary, what's the hold-up?).

During JQA's one-term Presidency--which was mostly marred with malevolence--the Chang and Eng Bunker Brothers, "Siamese Twins" born in Taiwan, first came to the United States in 1827. These conjoined twins would later reside in Mt. Airy, North Carolina, own slaves, and father 11 and 12 children respectively (with two different wives). In many ways, they were also a sign of the times, of America's unfolding, interdependent duality.

The controversial 1824 election paved the way for our two party system, with the Jacksonian faction becoming the modern Democratic Party, and the Adams faction absorbed by the National Republicans (aka Whig Party).

Culturally, the Adams/Jackson rematch in 1828 was a battle between America's emerging extremes. Adams hailed from the North (Massachusetts) Jackson from the South (Tennessee). Adams was from a long line of aristocrats, Jackson was born in poverty.

Jackson was charismatic, Adams dull. The son of the second President, John Adams' detractors called him "a chip off the old iceberg."

Adams was academic, Jackson a man of action. “J. Q. Adams can write” one slogan read, “Andy Jackson can fight”.

Adams was stately, Jackson characterized as a brute. Henry Clay once quipped "killing 2500 (?!) Englishman at the Battle of New Orleans" did not qualify Jackson for "the various difficult and complicated duties of the chief magistrate."

Adams was a deeply religious man, Jackson prone to vice. During the 1828 election, Adams supporters discredited Jackson for living with his wife before she was legally divorced from her first husband.

And where Adams favored a National Bank, Jackson pushed for independent state banks. Jackson won the election of 1828 by a landslide, and the dream of national banking was buried until the Republican, President Abraham Lincoln, signed the National Bank Act in 1863. (Today America is the only major economy that has a dual banking system, one that charters both state and national banks.)

Many of the Jackson and Adams' battles are echoed in today's cultural conversations. But today we have a new way to describe our binary nature: Red vs Blue.

Listen to a campaign song, "Hunters of Kentucky, or Half Horse and Half Alligator (another beautiful binary!)," sung by Jackson supporters in the 1824 election. It glorifies Andrew Jackson at the Battle of New Orleans.

The Panic of 1826, Again

They say the road to hell is paved with good intentions. In 1825, to deal with the "Indian Problem," the US Congress formed a region known as "Indian Country," lands West of the Mississippi (today Oklahoma). Their intentions were good.

"The removal of the tribes from the territory which they now inhabit would not only shield them from impending ruin, but promote their welfare and happiness," President James Monroe told Congress on January 27. He went so far as to say that without a defined Indian country "their degradation and extermination will be inevitable."

It's heartening to know that at least some of the President's contemporaries could see through his good intentions. New York County District Attorney Hugh Maxwell and twelve other prominent New Yorkers wrote in a pamphlet published in1825 that "the American Indians, now living upon lands derived from their ancestors and never alienated or surrendered, have a perfect right to the continued and undisturbed possession of these lands," and the "removal of any nation of Indians from their country by force would be an instance of gross and cruel oppression."

History was not on Mr. Maxwell's side, nor with his attempts to reform the financial industry a few years later. His prosecution of the Life & Fire Insurance Company, whose owners Jacob Barker, et al perpetuated a fraud that led to the Panic of 1826, resulted in a hung jury. (Eventually, Mr. Maxwell's efforts did lead to comprehensive reform, including: financial reporting requirements, accounting standards, and defined roles & responsibilities for directors, according to Professor Eric Hilt in a paper about the Panic of 1826.)

Mr. Maxwell's rationality was no match for his era's good intentions. For what lead Life & Fire's directors to commit fraud in the first place was in part driven by a desire (so they claimed) to extend credit to high-risk borrowers being ignored by traditional banks. When those borrowers started to default en masse, fraud appeared to be the only way to repay their investors, but unfortunately, even that didn't work.

Why was an insurance company doing a bank's work? In the 19th century, banking was the most profitable industry in America, and incumbent banks fought hard to protect their profits. To open a new one involved special-act charters and bitter legislative battles. Would-be owners required both political and financial capital, which few had in equal measure.

Enterprising merchants like Mr. Barker started circumventing these laws by forming insurance companies whose charter empowered them to lend their capital. In so doing, they created a new financial product called a post note. A typical post note transaction went as follows: a borrower approached an insurance company and requested a six-month IOU of $1000, minus a discount of say 3%. The borrower would then sell the discounted $970 post note on the money market, also paying a discount to the post note purchaser of say $30, receiving $940 in cash.

After six months, the borrower would repay the insurance company's IOU of $1000. The insurance company would repay the money market investor's post note of $970, yielding a $30 profit for both the insurance company and the investor.

While rates and terms varied, it was not unusual for post notes to trade at yields of 2 percent per month or more, compared to banks that were lending at yields of five percent per year, Professor Hilt's research found. Needless to say, these products were very profitable as long as default rates were low.

But higher yield meant higher risk, since borrowers who sought out post notes did so because they did not qualify for the less expensive credit from traditional banks. Despite their dubious quality, the corporate guaranty by the insurance company created a sense that the investments were safe. This combination of high yield and seemingly low risk sparked a credit boom.

"The judge the lawyer the doctor the clergy the widow the trustee of orphans all fell into the common vortex of investing in these bonds," Life and Fire Insurance Company director Jacob Barker wrote in a letter in 1827.

Like post notes, what made sub-prime mortgage-backed securities (MBS) so attractive to investors during the boom years was their high yield and perceived low risk. Unlike 1826, where the secondary market was created by the private sector, our government in many ways created the secondary market that gave sub-prime loans both the cash and perceived safety they needed to expand.

This was all done with good intentions. Looking to increase the homeownership rate and "foster affordable housing," the Housing and Urban Development (HUD) department issued regulations that required 55% of all government sponsored entities (GSEs) to purchase "affordable" loans from banks, either directly or through packaged MBS.

Most of these "affordable" loans were in fact sub-prime, "for persons with blemished or limited credit histories," and "carry a higher rate of interest than prime loans to compensate for increased credit risk," according to HUD.gov. In 2009, forty percent of mortgages were sub-prime according to Forbes.com.

By WTBrooks via Wikimedia Commons

By 2007, Fannie Mae and Freddie Max held $227 billion (one in six loans) in nonprime (aka subprime) pools, and approximately $1.6 trillion in low-quality loans altogether, according to Forbes.com and the Congressional Budget Office (CBO).

Value of mortgage-backed security issuances in $USD trillions, 1990-2009.
source: Congressional Budget Office (CBO)

"That was a huge, huge mistake," said Patricia McCoy, who teaches securities law at the University of Connecticut. "That just pumped more capital into a very unregulated market that has turned out to be a disaster."

Nonetheless, when the crisis hit in the Fall 2008, the financial world seemed to be blind-sided. "It's a new financial world on the verge of a complete reorganization," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

But was it a new financial world? In many ways, looking back to the Panic of 1826, we see ourselves looking back at us. Both were defined by financial innovations that seemed to defy the natural law of risk and reward, by promising a high yield and low risk. Both crises fooled investors into believing that transferring risk is the same thing as removing it. Both crises were made worse by the good intention that lending money to people who can't pay it back is good for society. Both crises proved it's not.

In our time, the implosion of the subprime lending market "has left a scar on the finances of black Americans," the Washington Post reported in 2012, "that not only wiped out a generation of economic progress but could leave them at a financial disadvantage for decades." (HUD.gov studies reveal that African-Americans are one-and-a-half times more likely to have a subprime loan than persons in white neighborhoods.)

Like the comprehensive financial reforms made after the 1826 panic, we can be reasonably sure that the numerous reforms issued after our own will fail to avert another crisis. This is because financial regulation cannot address the cause of financial crises that lives in our mirror. As long as there are borrowers who can't see through good intentions, and take on more debt then they can repay, there will be financial crises.

Real financial reform means living within our means, and abiding by the natural law of risk and reward. With the rising default rate on student loans, the increasing popularity of sub-prime auto loans, I fear that we have not yet learned our lesson. As Hugh Maxwell might say, if we learn anything at all, it will be the hard way.

"Daddy Warbucks," the Treaty of Versailles and Forming the Federal Reserve

PAUL M. WARBURG at the 1ST PAN AMERICAN FINANCIAL CONFERENCE, WASHINGTON, D.C., MAY 1915. 

On January 19, 1920, newspapers around the country were chronicling the US Senate's debate--for the second time--on whether to officially end war with Germany, ratify the Treaty of Versailles and join the League of Nations. In favor of ratification was a German emigre-turned-American-banker, Paul M. Warburg.

Echoing some of today's debates on Iraq, Warburg argued that by playing a part in the war, we had a moral responsibility in ensuring the peace. "There are many who, disgusted and disheartened, believe that we should wash our hands of Europe, and leave her to iron out her own affairs. It is too late for that. Europe relies on us," wrote Warburg in 1919.

And we relied on Europe, at least when it came to designing our modern banking system. Before advocating for world peace, Mr. Warburg was an advocate for centralized banking in the US. A descendant of a prominent German banking family, Mr. Warburg moved across the pond in 1895 after marrying into a prominent American banking family. Having an intimate view into both systems, he found the US uncharacteristically behind the times.

In a 1907 article printed in the New York Times, Warburg wrote that the American system was "in fact at about the same point that had been reached by Europe at the time of the Medicis, and by Asia, in all likelihood, at the time of Hammurabi." (Ouch!)

The European and Asian systems facilitated an elastic currency, Warburg said, "that follows the requirements of commerce." The United States' decentralized system, on the other hand, maintained an inelastic currency based on 6500 banks. "Under present conditions, instead of sending an army we send a soldier in to fight alone."

In passing the Federal Reserve Act of 1913, we heeded Warburg's advice and joined the league of centralized banking.  When it came to joining the League of Nations, however, we ignored the ex-German and soldiered it alone.

The purported inspiration for the "Daddy Warbucks" character in the Little Orphan Annie story, one could say Mr. Warburg was the father of our modern banking system. And in the hard-knocked world of finance, Warburg taught us that we shouldn't have to reinvent the wheel.

"I think that we are greatly mistaken if we believe that our country is so entirely different from all others that we should continue to do the opposite of what is done by them, while the system of all other important nations has proved to be excellent, and ours has proved to be defective."

I wonder what Mr. Warburg would think of today's healthcare system...

Banker's Notes cannot resist the convergence of banking and music, so let's enjoy Hard Knocked Life from the 1982 movie Annie, shall we?  At YouTube here >> http://youtu.be/-0bOH8ABpco



PS: In refusing to join the League of Nations, Senate Republicans used for the first time the "cloture," a procedural tool originally advocated by President Woodrow Wilson that allows Senators to place a time limit on the debate of a bill. Senate Republicans used the cloture against President Wilson to end debate on the Treaty, which eventually lead to its first rejection, on November 19, 1919.

In today's bipartisan bitterness, the cloture is still a favorite tool used by Republicans. Rachel Maddow found that the113th Congress is on track to be the most "do nothing" Congress in history in part because of Republican's frequent deployment of the tool. Of 2013's 64 roll call votes, the cloture was invoked more than the combined total of 1917 to 1978.

Banker's Notes 2013: Top 10 Best, Worst and Lessons Learned

In its inaugural year, Banker's Notes experienced the bliss of briefly going viral as well as the bust of boring posts. Below is the Banker's Notes Top 10 Best, Worst and Lesson Learned from 2013.

1) Most Insightful Commentary: Thank you +David Rider! 

BNer David Rider blessed Banker's Notes this year by not only reading the posts, but thoughtfully commenting, as in this one after the Panic of 1907 article:

2) Most Fun Email Received in Response to a Post: +Julie Kinloch and JP Morgan Jr Fights for his Life with the Help of His Powerful Wife, posted Sep 8

This post, detailing the failed assassination attempt on banker JP Morgan Jr, inspired the most interesting emails, such as this one from Julie Kinloch: "that one was fuckin fabulous and i love how he was wielding a pistol and a PhD from Cornell."


3) Most Supportive Parents: +Bill and Julie Wick

I want to give a shout out to my parents who not only signed up to receive (and consistently read!) Banker's Notes, but also recruited several of you to join as well. Thank you Mom and Dad!

4) Oldest Friend Reconnection: +Christine Cadrecha

Through Banker's Notes, I was able to reconnect with perhaps my oldest friend in the world, my one-time neighbor Christine Cadrecha. When we lived down the street from each other in Burlington, Vermont, we used to play pool in her basement and then swim in the pool in her backyard. Now we wade in the pool of the healthcare debate, thanks to the Banker's Notes post about the birthday of economist Kenneth Arrow, who said "There's really no logical relation whatever between employment and health care..."

5) Most Corrected Post: Federal Credit Union Act is Passed, posted Jun 25

In this post, I think I let my personal feeling that credit unions should be taxed just like banks cloud my reporting. Thankfully, I received this corrective comment from a careful reader who randomly found Banker's Notes. Our exchange is below:

6) Most Google+ Recommendations: Panic of 1907 vs. Crisis of 2008, posted Nov 18

This essay was inspired by a speech by +Ben Bernanke, and it not only received the most recommendations, it was also re-posted on the website StrategyDriven.com. One of the longer BN posts, it showed me that telling how we got to where we are, even on the dry topic of central banking, can be interesting and not just to me!

This post also benefited from a retweet from New Jersey banker +Jeff Marsico.

7) Most Community Building: Wilmington Coup D'Etat, posted Nov 10

While this post did not receive many pageviews, it demonstrated the power of the internet to build community. Through it, I was introduced to Wilmington filmmaker Chris Everett who is creating a documentary on the Wilmington Coup D'Etat. You can learn more about his film "Wilmington on Fire" and his kickstarter campaign here.

8) The Best: The Alaska Appropriations Affair, posted Oct 20

This story about the House of Representatives' refusal in the 1860s to pay Russia for our purchase of Alaska (even after we celebrated its inclusion as a US territory) received the most pageviews.

I think what made this post the most popular was the strong link between historical and current events. When it posted, our government had just shutdown because Congress had similarly refused to pay for ObamaCare even after the law's blessing by the Supreme Court.

This post also benefited from a retweet from +Alex Tabarrok, an economics professor at George Mason University and founder of the blog Marginal Revolution.

9) The Worst: Ad Man Bell Bernach: "The truth isn't the truth until people believe you", posted Aug 17

With three piddly pageviews (most likely all from me!), this story commemorating the birth of the inventor of the "Mikey" Life Cereal commercials was the least popular post. From this experience, I came to appreciate the wisdom of the ancient adage "embedded video does not an interesting post make." There are no shortcuts in blogging!

10) My Favorite Banker's Notes Post of 2013: Ship of Gold, posted Aug 24

I think my most favorite post of 2013 was the "Ship of Gold." This story delighted because when it came to a choice between life and money, survivors of this sinking ship chose life.

Did you have a favorite post this year?

If you have any thoughts on Banker's Notes--what worked well and especially what could work better in 2014--I hope that you will comment on this post, or email me!  Cara@bankersnotes.com

As always thanks for reading!

Banker's Notes will be back Sunday Jan 12 (I'm on a 10-day meditation retreat Dec 27-Jan 7). Until then, Happy New Year to you!

Love,
Cara

'Tis the Season for Opinons: Jefferson's Embargo Act of 1807

President Jefferson addressing a group of disgruntled men, as he defends the policy of his Embargo which, combined with the Non-Intercourse Act, was intended to bring about a suspension of foreign commerce. Circa 1808, from LOC.gov

In a December 20 op-ed posted on Forbes.com, commentators Mieke Eoyang and Gabriel Horwitz proclaimed our founding fathers would be "horrified" by the NSA's collection efforts. Specifically, that our third President would be "dismayed" that our government "was doing things that could hurt our competitiveness and our ability to set the terms of global trade."

Perhaps in hindsight, yes. But with the Embargo Act, signed into law on December 22, 1807, Thomas Jefferson did his part to both expand government and limit our global competitiveness.

A ban on trade between the United Kingdom and France was intended as a diplomatic response to these militarily-superior nation's flagrant refusal to honor US neutrality during the Napoleonic Wars. Instead of economic harm to our enemies, however, the policy inflicted a devastating burden on the U.S. economy, while managing only to postpone the war until 1812.

According to historian Leonard Levy, Jefferson's doctrinaire approach to enforcing the embargo violated his own commitment to limited government. It also had the pernicious effect of undermining American citizens' faith that their government could execute its own laws fairly, and strengthened the conviction among America's dissenters that her republican form of government was inept and ineffectual.

After just 15 months, the embargo was revoked on March 1, 1809, in the last days of Jefferson's presidency.

An opinion piece from the time, taken from the Library of Congress, reveals that expanded government--even when enacted by a cherished founding father!--is an idea whose unpopularity stands the test of time. Below one citizen expressed his frustration in an aa bb rhyming pattern. (Oh that all op-eds could be written in verse.)

A Poem about General Washington with Some Remarks on Jeffersonian Policy
Reprinted by Nathaniel Coverly, Boston 1807

But we must all forbear to sigh
Since WASHINGTON was born to die,
He ever was his country's friend
But Washington must have an end
And must it be since he is dead,
That all our happiness is fled;
Behold the dismal change of late,
See JEFFERSON in chair of state.

He took to presidential chair,
And then soon after we did hear,
Of his great doings, and his fame
He sent to France and fetch'd Tom Paine,
To give him counsel and advice
To buy Louisiana with great price,
For want of money sold our ships
I'm sure we all know how he nips

Gunboats--he then went and built
To save men's blood from being spilt
Poor things indeed we all do know,
That ne'er defend us from the foe,
He then exerted all his wits
And laid an embargo on our ships,
And for fear that we should trade
'Gainst Canada embargoes laid.

Great Washington our friend is dead
And Jefferson reigns in his stead,
Much reason then to mourn and sigh,
But Jefferson must die
A man he is a frail one too
At sad experience now doth shew
Then will forsake out present head
And chase a better in his stead.

Banker's Notes would like to wish all of you a very Happy Holidays, and say a big THANK YOU for blessing me by joining the Banker's Notes family this year.

With gratitude,
Cara