Ever since President Andrew Jackson orchestrated the destruction of the Second Bank of the United States in 1832, Whig and later Republican political leaders had wanted to establish some type of national banking system. During the antebellum period, the principal form of currency in the United States had been notes issued by state-chartered banks. With the dismantling of the Second Bank of the United States, which had kept state banknotes in check, the number of different banknotes in circulation dramatically increased. When the Civil War began, the advocates of a national banking system were given the chance to remedy the situation. Several southern Democrats who had favored state-chartered banks and opposed any form of centralized banking system left Congress, thereby giving the Republicans a majority. Salmon P. Chase, the secretary of the treasury in the Lincoln administration, also argued that a national banking system would provide a more stable, uniform paper currency and would help finance the Union war effort by providing a large market for government bonds.
Congressional legislation in 1863, 1864, and 1865 created a new national banking system that existing or newly formed banks could join if they had enough capital and were willing to invest one-third of it in federal bonds. The national banknotes were to be uniform in design and backed by federal bonds that the banks would buy and deposit with the Comptroller of the Currency (a new division within the Treasury Department) in return for the notes. If a national bank should fail, the bonds would then be liquidated and the note holders compensated without loss.
Although the idea sounded feasible, it did not work out as planned. Note-issuing banks did not give up their state charters and join the national banking system, as was anticipated, until 1865 when legislation placed a prohibitive 10 percent tax on state banknote issues. Existing banks found the new laws more restrictive than the ones they had been operating under. These restrictions included bond purchase requirements, a limitation on the amount of notes any one national bank could issue to 90 percent of the market value of the bonds it deposited with the Comptroller, and a limit of $300 million on the total number of national banknotes issued for the nation. The new legislation also set minimum capital requirements for national banks that were too high to make joining the system profitable for banks in small towns. They also prohibited the popular practice of extending loans on the basis of real estate collateral, a major drawback in rural, agricultural areas, where land is the major asset possessed by many of the people. Faced with these operating restrictions, many existing banks chose not to give up their state charters and did not join the national banking system. The goal to make all banks national banks during the Civil War was not achieved, but by the end of 1865 there were 1,600 national banks, mostly former state banks, located primarily in the Northeast.
The shortcomings of this policy had a tremendous effect on the nation’s economy in the late 19th century. The national banking system with its many restrictive policies never flourished in the nation’s small towns and rural areas and as a result remained a mostly urban and northeastern institution. Furthermore, the state banks (which were favored by many Americans living in rural, agricultural parts of the country) were nearly destroyed by the 10 percent tax Congress placed on state banknotes. The idea behind this tax was to force all banks (state-chartered and private) to join the national system. The system soon earned the reputation in rural America as the tool of the wealthy industrialists and financiers of the urban Northeast.
Another problem that plagued the national banking system in the post-Civil War years was its susceptibility to financial panics. It was unable to do anything about the periodic shortages of cash and credit that are a natural part of the BUSINESS CYCLE. The system was based on cash reserves, and the total amount of cash could not be quickly altered because the system lacked a central institution that could hold the reserves of the commercial banks and, most importantly, could increase those reserves to meet demand. The politics of banking eventually became intertwined with the CURRENCY ISSUE as financial panics and industrial depressions struck the nation in 1873, 1884, and 1893. Those Americans most affected by the economic downturns, the farmers, targeted the national banking system and the government’s reliance on the gold standard for their most vocal attacks.
Members of the EARMERS’ ALLIANCES and later the People’s Party (Populists) called for currency inflation in the form of either an increase in the amount of greenbacks (fiat money issued during the Civil War) in circulation or the free and unlimited coinage of silver (Free Silver movement). They also advocated the abolition of the national banking system and the creation of a subtreasury system to take its place. In 1913 the more flexible, decentralized Federal Reserve System would replace the national banking system as the central banking institution of the United States in 1913.
Further reading: Morton Keller, Affairs of State: Public Life in Late Nineteenth-Century America (Cambridge, Mass.: Harvard University Press, 1977); Edward C. Kirkland, Industry Comes of Age: Business, Labor, and Public Policy, 1860-1897 (New York: Holt, Rinehart and Winston, 1961); Sidney Ratner, James H. Soltow, and Richard Sylla, The Evolution of the American Economy: Growth, Welfare, and Decision Making (New York: Basic Books, 1979).
—Phillip Papas
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