The most important of the bank experiments was the free banking law. The New York Assembly passed the first such law in 1838. Actually, between the beginning of the agitation for the New York system and final passage of the act establishing it, a Michigan statute provided for a similar plan, but the chief influence on American banking derives from the New York law. The adjective free indicates the most important provision of the law, under which any individual or group of individuals, upon compliance with certain regulations, could start a bank. Under the old rule, the privilege of starting a bank had to be granted by a special legislative act, which frequently gave rise to political favoritism and corruption. Increased competition promised improved services and a reduction of legislative corruption.
But in other respects, the “free banks” were decidedly unfree. To protect noteholders and sometimes to boost the state’s credit, the free banking laws required the banks to deposit bonds, usually federal bonds or those issued by the state where the bank was located, with the state banking authority. If a bank refused to redeem a note in specie, the holder could protest to the state banking authority, which would then sell the bonds and redeem all of the bank’s notes. The rules governing the amount and type of bonds that had to be deposited had a great deal to do with the success or failure of the system. If too much backing was required for each note issued, no banks would be set up. If too little backing was required, the way might be opened for wildcat banking.
If the required backing protected note holders while permitting the bankers a reasonable profit, however, the system would work well.
In New York, to take the most important example, free banking was successful. The system expanded rapidly, and there were few failures. Indeed, the free banking systems of New York and Ohio were the models for the national banking system adopted during the Civil War.
But Michigan’s free banking law of 1837 produced a famous episode of wildcat banking. Despite apparent safeguards, the law permitted dubious securities to be put up as a guarantee of note redemption and unscrupulous bankers took advantage. Under the Michigan law, all a bank had to do to start operation was to show that it had specie on hand. Enterprising bankers showed an amazing ingenuity in outwitting examiners. Moreover, specie payments at the time were suspended nationwide because of a banking crisis, so the would-be wildcat banker did not even have to fear immediate withdrawals. Two bank commissioners noted a remarkable similarity in the packages of specie in the vaults of several banks on their examination list and later discovered that a sleigh drawn by fast horses preceded them as they went from bank to bank. Specie, some observers said, flew about the backwoods of Michigan with the “celerity of magic.” Nearly all banks operating on such a basis failed and disappeared by 1840, but not before a victimized public had been stuck with their worthless notes.
World History
